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**UNITED STATES SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

 

| **(Mark One)**                                                                                     | ** ** | ** **                                                                                              |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                               | ** ** | ** **                                                                                              |
| **þ**                                                                                         | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                               | ** ** | ** **                                                                                              |
| **For  the quarterly period ended March 31, 2010**                                            |
| **OR**                                                                                             |
| ** **                                                                                         |
| **o**                                                                                              | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**           |
|                                                                                               | ** ** | ** **                                                                                              |
| **For  the transition period  from          to** |

 

**Commission File Number: 001-33138**

 

**KBW,INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**

 (State or Other Jurisdiction of  Incorporation or Organization) | ** ** | **13-4055775**

 (I.R.S. Employer Identification No.) |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------|

 

**787Seventh Avenue, New York, New York 10019**

 (Address of principal executive offices)

**Registrant’stelephone number: (212) 887-7777**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 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 suchreports), and (2) has been subject to such filing requirements for thepast 90 days. Yes    þ  No    o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submit andpost such files).    Yes o            No  o

 

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

 

Large accelerated filer    þ     Acceleratedfiler     o     Non-accelerated filer     o     Smaller reporting company     o

(Do not check if asmaller reporting company)

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes    o   No     þ

 

The number of shares ofthe Registrant’s common stock, par value $0.01 per share, outstanding as April 30,2010 was 35,471,666, which number includes 4,037,079 shares representingunvested restricted stock awards and excludes 1,046,448 shares underlyingvested restricted stock units.

 

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**TABLE OF CONTENTS**

 
| ** **                                                                                                    | **Page**   |
|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                    | **Number** |
|                                                                                                          |       |
| AVAILABLE  INFORMATION                                                                                        | 1          |
|                                                                                                          |       |
| PART  I–FINANCIAL INFORMATION                                                                            | 2          |
|                                                                                                          |       |
| Item 1. Financial Statements                                                                                  | 2          |
|                                                                                                          |       |
| Consolidated Statements of Financial Condition–March  31, 2010 (Unaudited) and December 31, 2009         | 2          |
|                                                                                                          |       |
| Consolidated Statements of Operations–Three Months  ended March 31, 2010 and 2009 (Unaudited)            | 3          |
|                                                                                                          |       |
| Consolidated Statement of Changes in Stockholders'  Equity–Three Months ended March 31, 2010 (Unaudited) | 4          |
|                                                                                                          |       |
| Consolidated Statements of Cash Flows–Three Months  ended March 31, 2010 and 2009 (Unaudited)            | 5          |
|                                                                                                          |       |
| Notes to Consolidated Financial Statements                                                                    | 6          |
|                                                                                                          |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations           | 21         |
|                                                                                                          |       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                           | 32         |
|                                                                                                          |       |
| Item 4. Controls and Procedures                                                                               | 33         |
|                                                                                                          |       |
| PART II–OTHER  INFORMATION                                                                               | 34         |
|                                                                                                          |       |
| Item  1. Legal Proceedings                                                                                    | 34         |
|                                                                                                          |       |
| Item 1A. Risk Factors                                                                                         | 35         |
|                                                                                                          |       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                          | 35         |
|                                                                                                          |       |
| Item 3. Defaults Upon Senior Securities                                                                       | 35         |
|                                                                                                          |       |
| Item  4. Other Information                                                                                    | 35         |
|                                                                                                          |       |
| Item 5. Exhibits                                                                                              | 35         |
|                                                                                                          |       |
| SIGNATURES                                                                                                    | 36         |
|                                                                                                          |       |
| EXHIBIT INDEX                                                                                                 | 37         |
|                                                                                                          |       |
| EX-31.1: CERTIFICATION                                                                                        |       |
|                                                                                                          |       |
| EX-31.2: CERTIFICATION                                                                                        |       |
|                                                                                                          |       |
| EX-32.1: CERTIFICATION                                                                                        |       |
|                                                                                                          |       |
| EX-32.2: CERTIFICATION                                                                                        |       |
|                                                                                                               |            |  |

 

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**AVAILABLE INFORMATION**

 

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

 

We will make availablefree of charge through our website http://www.kbw.com, our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, proxystatements, Forms 3, 4 and 5 filed by or on behalf of directors, executiveofficers and certain large stockholders, and any amendments to those documentsfiled or furnished pursuant to the Exchange Act. These filings will becomeavailable as soon as reasonably practicable after such material iselectronically filed with or furnished to the SEC.

 

We also make available, on the Investor Relations page ofour website, our (i) Corporate Governance Guidelines, (ii) Code ofBusiness Conduct and Ethics, (iii) Supplement to Code of Business Conductand Ethics for CEO and Senior Financial Officers, and (iv) charters ofeach of the Audit, Compensation, and Corporate Governance and NominationsCommittees of our Board of Directors. You will need to have Adobe AcrobatReader software installed on your computer to view these documents, which arein the PDF format. These documents are also available in print free of chargeto any person who requests them by writing or telephoning: KBW, Inc.,Office of the Corporate Secretary, 787 Seventh Avenue, New York, New York,10019, U.S.A., telephone number (212) 887-7777. These documents, as wellas the information on our website, are not a part of this report.

 

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**PART I-FINANCIALINFORMATION**

 

**Item 1.   Financial Statements.**

 

**KBW, INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Financial Condition**

**(Dollars in thousands)**

 
| ** **                                                                                                                                        | ** ** | **March 31,**        | ** ** | ** **            |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------|
| ** **                                                                                                                                        | ** ** | **2010**                  | ** ** | **December 31,** |
| ** **                                                                                                                                        | ** ** | **(unaudited)**           | ** ** | **2009**              |
| **ASSETS**                                                                                                                                        |       |                      |       |                  |   |   |
| Cash and cash  equivalents                                                                                                                        | $          |                      | 177,220    |                  | $ |   | 203,180 |   |
| Financial  instruments owned, at fair value:                                                                                                      |       |                      |       |                  |   |   |
| Equities                                                                                                                                          |       | 81,812                    |       |                  | 56,720 |   |
| Corporate and  other debt                                                                                                                         |       | 73,911                    |       |                  | 75,754 |   |
| Mortgage-backed  securities                                                                                                                       |       | 33,656                    |       |                  | -     |   |
| Other  investments                                                                                                                                |       | 45,092                    |       |                  | 41,917 |   |
|                                                                                                                                              |       | 234,471                   |       |                  | 174,391 |   |
| Receivables from  clearing brokers                                                                                                                |       | 82,803                    |       |                  | 161,811 |   |
| Accounts  receivable                                                                                                                              |       | 39,659                    |       |                  | 28,703 |   |
| Income taxes  receivable                                                                                                                          |       | 831                       |       |                  | 1,129 |   |
| Furniture,  equipment and leasehold improvements, at cost, less accumulated depreciation  and amortization of $26,835 in 2010 and $25,636 in 2009 |       | 18,636                    |       |                  | 18,800 |   |
| Other assets                                                                                                                                      |       | 43,143                    |       |                  | 43,354 |   |
| Total assets                                                                                                                                      | $          |                      | 596,763    |                  | $ |   | 631,368 |   |
|                                                                                                                                              |       |                      |       |                  |   |   |
| ** **                                                                                                                                        |       |                      |       |                  |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                    |       |                      |       |                  |   |   |
| Liabilities:                                                                                                                                      |       |                      |       |                  |   |   |
| Financial  instruments sold, not yet purchased, at fair value:                                                                                    |       |                      |       |                  |   |   |
| Equities                                                                                                                                          | $          |                      | 49,509     |                  | $ |   | 31,288 |   |
| Corporate debt                                                                                                                                    |       | 2,408                     |       |                  | 4,723 |   |
| U.S. Government  and agency securities                                                                                                            |       | 4,302                     |       |                  | 962 |   |
|                                                                                                                                              |       | 56,219                    |       |                  | 36,973 |   |
| Accounts  payable, accrued expenses, and other liabilities                                                                                        |       | 63,056                    |       |                  | 134,658 |   |
| Income taxes  payable                                                                                                                             |       | 14,144                    |       |                  | 10,668 |   |
| Total  liabilities                                                                                                                                |       | 133,419                   |       |                  | 182,299 |   |
|                                                                                                                                              |       |                      |       |                  |   |   |
| Stockholders’  equity:                                                                                                                       |       |                      |       |                  |   |   |
| Preferred stock                                                                                                                                   |       | -     |       |                  | -     |   |
| Common stock                                                                                                                                      |       | 314                       |       |                  | 307 |   |
| Paid-in capital                                                                                                                                   |       | 165,542                   |       |                  | 161,168 |   |
| Retained  earnings                                                                                                                                |       | 310,247                   |       |                  | 298,626 |   |
| Notes receivable  from stockholders                                                                                                               |       | (120                      | )          |                  | (609 | ) |
| Accumulated  other comprehensive loss                                                                                                             |       | (12,639                   | )          |                  | (10,423 | ) |
| Total  stockholders’ equity                                                                                                                  |       | 463,344                   |       |                  | 449,069 |   |
| Total  liabilities and stockholders’ equity                                                                                                  | $          |                      | 596,763    |                  | $ |   | 631,368 |   |

 

See accompanying notes toconsolidated financial statements.

 

2

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**KBW INC.AND SUBSIDIARIES**

**Consolidated Statements of Operations**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 
| ** **                                             | ** ** | **Three  Months Ended** |
|--------------------------------------------------------|------------|-------------------------|
| ** **                                             | ** ** | **March 31,**      |
| ** **                                             | ** ** | **2010**                | ** ** | **2009** |
| Revenues:                                              |       |                    |   |   |   |   |
| Investment  banking                                    | $          |                    | 69,962 |   | $ |   | 26,860 |   |
| Commissions                                            |       | 35,404                  |   |   | 36,019 |   |
| Principal transactions,  net                           |       | 19,047                  |   |   | 4,116 |   |
| Interest and  dividend income                          |       | 2,884                   |   |   | 1,738 |   |
| Investment  advisory fees                              |       | 294                     |   |   | 313 |   |
| Other                                                  |       | 5,719                   |   |   | 3,230 |   |
| Total revenues                                         |       | 133,310                 |   |   | 72,276 |   |
| Expenses:                                              |       |                    |   |   |   |   |
| Compensation and  benefits                             |       | 81,878                  |   |   | 45,667 |   |
| Occupancy and  equipment                               |       | 5,612                   |   |   | 5,159 |   |
| Communications  and data processing                    |       | 7,656                   |   |   | 6,660 |   |
| Brokerage and  clearance                               |       | 5,086                   |   |   | 3,882 |   |
| Business  development                                  |       | 3,460                   |   |   | 3,032 |   |
| Interest                                               |       | 258                     |   |   | 169 |   |
| Other                                                  |       | 9,050                   |   |   | 5,777 |   |
| Total expenses                                         |       | 113,000                 |   |   | 70,346 |   |
| Income before  income taxes                            |       | 20,310                  |   |   | 1,930 |   |
| Income tax  expense                                    |       | 8,689                   |   |   | 1,200 |   |
| Net income                                             | $          |                    | 11,621 |   | $ |   | 730 |   |
|                                                   |       |                    |   |   |   |   |
| Earnings per  common share:                            |       |                    |   |   |   |   |
| Basic                                                  | $          |                    | 0.32 |   | $ |   | 0.02 |   |
| Diluted                                                | $          |                    | 0.32 |   | $ |   | 0.02 |   |
|                                                   |       |                    |   |   |   |   |
| Weighted average  number of common shares outstanding: |       |                    |   |   |   |   |
| Basic                                                  |       | 32,240,838              |   |   | 31,354,507 |   |
| Diluted                                                |       | 32,240,838              |   |   | 31,354,507 |   |

 

See accompanying notes toconsolidated financial statements.

 

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**KBW,INC. AND SUBSIDIARIES**

**Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income**

**(unaudited)**

**(Dollars in thousands, except per share information)**

 
|                                                                                                 |   |          |   |                      |   |                                        |                                        |         |                                        |                                        |                                        |              | **Notes**                                   |                   | **Accumulated** |                                        |      |
|------------------------------------------------------------------------------------------------------|--------|---------------|--------|---------------------------|--------|---------------------------------------------|---------------------------------------------|--------------|---------------------------------------------|---------------------------------------------|---------------------------------------------|-------------------|---------------------------------------------|------------------------|-----------------|---------------------------------------------|-----------|
|                                                                                                 |   |          |   |                      |   |                                        |                                        |         |                                        |                                        |                                        |              | **Receivable**                              |                   | **Other**       |                                        | **Total** |
|                                                                                                 |   | **Preferred** |   | **Common**                |   | **Paid-in**                                 |                                        | **Retained** |                                        | **from**                                    |                                        | **Comprehensive** |                                        | **Stockholders’** |
|                                                                                                 |   | **Stock**     |   | **Stock**                 |   | **Capital**                                 |                                        | **Earnings** |                                        | **Stockholders**                            |                                        | **Loss**          |                                        | **Equity**             |
| **Balance  at December 31, 2009**                                                               | $      | -             | $      | 307                       | $      | 161,168                                     |                                        | $            | 298,626                                     | $                                           | (609                                        | )                 | $                                           | (10,423                | )               | $                                           | 449,069   |   |
| Net income                                                                                           |   | -             |   | -     |   | -        |                                        |         | 11,621                                      |                                        | -        |              | -        |                   | 11,621          |                                        |
| Other  comprehensive loss, currency translation adjustment                                           |   | -             |   | -     |   | -        |                                        |         | -        |                                        | -        |              | (2,216                                      | )                      | (2,216          | )                                           |
| Total  comprehensive income                                                                          |   |          |   |                      |   |                                        |                                        |         |                                        |                                        |                                        |              |                                        |                   | 9,405           |                                        |
| Amortization of  stock-based compensation                                                            |   | -             |   | -     |   | 14,294                                      |                                        |         | -        |                                        | -        |              | -        |                   | 14,294          |                                        |
| Cancellation of  433,879 shares of restricted stock in satisfaction of withholding tax  requirements |   | -             |   | (4                        | )      | (11,580                                     | )                                           |         | -        |                                        | -        |              | -        |                   | (11,584         | )                                           |
| Issuance of  1,114,502 shares of common stock                                                        |   | -             |   | 11                        |   | 25,856                                      |                                        |         | -        |                                        | -        |              | -        |                   | 25,867          |                                        |
| Stock-based  awards vested                                                                           |   | -             |   | -     |   | (25,808                                     | )                                           |         | -        |                                        | -        |              | -        |                   | (25,808         | )                                           |
| Tax benefit  related to stock-based awards                                                           |   | -             |   | -     |   | 1,612                                       |                                        |         | -        |                                        | -        |              | -        |                   | 1,612           |                                        |
| Repayment of  notes receivable from stockholders                                                     |   | -             |   | -     |   |                                        | -        |         |                                        | -        |                                        |              | 489                                         |                   |            | -        |      |   | 489 |   |
| **Balance  at March 31, 2010**                                                                  | $      | -             | $      | 314                       |   | $                                           | 165,542                                     |         | $                                           | 310,247                                     |                                        | $                 | (120                                        | )                      | $               | (12,639                                     | )         | $ | 463,344 |   |

 

**Descriptionof preferred stock and details:**

 
| ** **              | ** ** | ** **                    | ** ** | **Number  of Shares** | ** ** |
|-------------------------|------------|-------------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **Par  Value**                | ** ** | **Authorized**        | ** ** | **Issued** | ** ** | **Outstanding** | ** ** |
|                    |       |                          |       |                  |       |   |   |   |   |
| March 31,  2010    |       | $    0.01 |       | 10,000,000            |       | - |   | - |   |
| December 31,  2009 |       | $    0.01 |       | 10,000,000            |       | - |   | - |   |

 

**Descriptionof common stock and details:**

 
| ** **              | ** ** | ** **                    | ** ** | **Number  of Shares** | ** ** |
|-------------------------|------------|-------------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **Par  Value**                | ** ** | **Authorized**        | ** ** | **Issued****(*********)** | ** ** | **Outstanding****(*********)** | ** ** |
|                    |       |                          |       |                  |       |   |   |   |   |
| March 31,  2010    |       | $    0.01 |       | 140,000,000           |       | 31,430,320 |   | 31,430,320 |   |
| December 31,  2009 |       | $    0.01 |       | 140,000,000           |       | 30,749,697 |   | 30,749,697 |   |

 

(*)These share amounts exclude legally vested restrictedstock units.

 

See accompanying notes toconsolidated financial statements.

 

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**KBW,INC. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

**(unaudited)**

**(Dollars in thousands)**

 
| ** **                                                                        | ** ** | **Three  Months Ended March 31,** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------|
| ** **                                                                        | ** ** | **2010**                               | ** ** | **2009** |
|                                                                              |       |                                   |   |   |   |   |
| Cash flows from  operating activities:                                            |       |                                   |   |   |   |   |
| Net income                                                                        | $          |                                   | 11,621 |   | $ |   | 730 |   |
| Adjustments to  reconcile net income to net cash used in operating activities:    |       |                                   |   |   |   |   |
| Amortization of  stock-based compensation                                         |       | 14,294                                 |   |   | 12,025 |   |
| Depreciation and  amortization                                                    |       | 1,269                                  |   |   | 1,192 |   |
| Deferred income  tax expense                                                      |       | 3,064                                  |   |   | 393 |   |
|                                                                              |       |                                   |   |   |   |   |
| (Increase)  decrease in operating assets:                                         |       |                                   |   |   |   |   |
| Financial  instruments owned, at fair value                                       |       | (60,700                                | ) |   | 11,440 |   |
| Securities  purchased under resale agreements                                     |       | -                  |   |   | (8,058 | ) |
| Receivables from  clearing brokers                                                |       | 78,641                                 |   |   | 4,314 |   |
| Accounts  receivable                                                              |       | (11,066                                | ) |   | (200 | ) |
| Income taxes  receivable                                                          |       | 252                                    |   |   | 2,216 |   |
| Other assets                                                                      |       | (2,985                                 | ) |   | (1,309 | ) |
| Increase  (decrease) in operating liabilities:                                    |       |                                   |   |   |   |   |
| Financial  instruments sold, not yet purchased, at fair value                     |       | 19,396                                 |   |   | 18,231 |   |
| Securities sold  under repurchase agreements                                      |       | -                  |   |   | 8,613 |   |
| Accounts  payable, accrued expenses and other liabilities                         |       | (71,160                                | ) |   | (92,354 | ) |
| Income taxes  payable                                                             |       | 3,477                                  |   |   | 149 |   |
| Net cash used in  operating activities                                            |       | (13,897                                | ) |   | (42,618 | ) |
| Cash flows from  investing activities:                                            |       |                                   |   |   |   |   |
| Purchase of  furniture, equipment and leasehold improvements                      |       | (1,115                                 | ) |   | (1,016 | ) |
| Net cash used in  investing activities                                            |       | (1,115                                 | ) |   | (1,016 | ) |
| Cash flows from  financing activities:                                            |       |                                   |   |   |   |   |
| Issuance of  shares of common stock                                               |       | 59                                     |   |   | 53 |   |
| Cancellation of  restricted stock in satisfaction of withholding tax requirements |       | (11,584                                | ) |   | (4,463 | ) |
| Excess  (shortfall) net tax benefit related to stock-based awards                 |       | 1,612                                  |   |   | (1,334 | ) |
| Repayment of  notes receivable from stockholders                                  |       | 489                                    |   |   | 1,516 |   |
| Net cash used in  financing activities                                            |       | (9,424                                 | ) |   | (4,228 | ) |
| Currency  adjustment:                                                             |       |                                   |   |   |   |   |
| Effect of  exchange rate changes on cash                                          |       | (1,524                                 | ) |   | (994 | ) |
| Net decrease in  cash and cash equivalents                                        |       | (25,960                                | ) |   | (48,856 | ) |
| Cash and cash  equivalents at the beginning of the period                         |       | 203,180                                |   |   | 194,981 |   |
| Cash and cash  equivalents at the end of the period                               | $          |                                   | 177,220 |   | $ |   | 146,125 |   |
|                                                                              |       |                                   |   |   |   |   |
| Supplemental  disclosures of cash flow information:                               |       |                                   |   |   |   |   |
| Cash paid during  the period for:                                                 |       |                                   |   |   |   |   |
| Income taxes                                                                      | $          |                                   | 906 |   | $ |   | 103 |   |
| Interest                                                                          | $          |                                   | 224 |   | $ |   | 260 |   |

 

See accompanying notes toconsolidated financial statements.

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

**(1)****             ****Organizationand Basis of Presentation**

 

Theconsolidated financial statements include the accounts of KBW, Inc., andits wholly owned subsidiaries (the “Company”), Keefe, Bruyette & Woods, Inc.(“Keefe”), Keefe, Bruyette & Woods Limited (“KBWL”), Keefe, Bruyette &Woods Asia Limited (“KBWAL”), KBW Asset Management, Inc. and KBW Ventures, Inc.Keefe is a regulatory member of the Financial Industry Regulatory Authority(“FINRA”) and is principally a broker-dealer in securities and a market-makerin certain financial services stocks and bonds in the United States. KBWL isauthorized and regulated by the U.K. Financial Services Authority (“FSA”) and amember of the London Stock Exchange, Euronext, SWX Europe and DeutscheBoerse.  KBWAL is a securities firmlicensed and regulated by the Securities and Futures Commission in HongKong.   Keefe’s, KBWL’s and KBWAL’s customersare predominantly institutional investors including other brokers and dealers,commercial banks, asset managers and other financial institutions. Keefe has aclearing arrangement with Pershing LLC on a fully disclosed basis. KBWL has aclearing arrangement with Pershing Securities Limited on a fully disclosedbasis and is responsible for clearance and settlement for both KWBL and KBWAL.

 

These consolidated financial statements and thesenotes are unaudited and exclude some of the disclosures required in annualfinancial statements. These consolidated financial statements should be read inconjunction with the Company’s consolidated financial statements and notesthereto for the year ended December 31, 2009 included in its Annual Reporton Form 10-K filed with the SEC. These consolidated financial statementsreflect all adjustments (consisting of normal recurring adjustments) that are,in the opinion of management, necessary for the fair statement of the resultsfor the interim periods. The results of operations for interim periods are notnecessarily indicative of results for the entire year.

 

**(2)****             ****Summary ofSignificant Accounting Policies**

 

***(a)******              ******Financial Accounting Standards Board (“FASB”)Accounting Standards Codification***

 

In September 2009, the Company adopted FASBStatement of Financial Accounting Standards (“SFAS”) No. 168, *The “FASB Accounting Standards CodificationTM” and theHierarchy of Generally Accepted Accounting Principles* (FASBAccounting Standards Codification 105)*. *SFAS 168 establishes the FASBAccounting Standards CodificationTM (“Codification” or “ASC”) as the singlesource of authoritative U.S. generally accepted accounting principles (“GAAP”)recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of theSEC under authority of federal securities laws are also sources of authoritativeGAAP for SEC registrants.  TheCodification supersedes all existing non-SEC accounting and reportingstandards.  All other nongrandfathered,non-SEC accounting literature not included in the Codification isnonauthoritative.

 

Following the Codification, the Board will notissue new standards in the form of Statements, FASB Staff Positions or EmergingIssues Task Force Abstracts.  Instead, itwill issue Accounting Standards Updates, which will serve to update theCodification, provide background information about the guidance and provide thebasis for conclusions on the changes to the Codification.

 

Reference to GAAP requirements, where provided inthese financial statements are to the ASC.

 

***(b)******              ******Principles of Consolidation***

 

The consolidated financialstatements have been prepared in accordance with GAAP and include the accountsof the Company and its consolidated subsidiaries. All intercompany transactionsand balances have been eliminated.

 

The Company consolidatesentities for which it has a controlling financial interest as defined in ASC810, *Consolidation*.  The usual condition for a controllingfinancial interest is ownership of a majority voting interest.  As a result, the Company generallyconsolidates entities when they have ownership, directly or indirectly, of over50 percent of the outstanding voting shares of another entity.  Since a controlling financial interest may beachieved through arrangements that do not involve voting interest, the Companyalso evaluates entities for consolidation under the “variable interest model”in accordance with ASC 810.  The Companyconsolidates variable interest entities when its interests in the entity areexpected to absorb a majority the entity’s expected losses, or expectedresidual returns, or both.  The Companyhad no variable interest entities that required consolidation at March 31,2010.

 

In addition, the Companyevaluates its investments in limited partnerships under ASC 810.  Under ASC 810, the general partners inlimited partnerships are presumed to have control unless the limited partnershave either a substantial ability to dissolve the 

 

6

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

limited partnership or otherwise can removethe general partner without cause or have substantial participating rights.There were no limited partnership interests that required consolidation at March 31,2010.

 

***(c)******               ******Use of Estimates***

 

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

 

***(d)******              ******Cash and Cash Equivalents***

 

Cashequivalents include investments with an original maturity of three months orless. Due to the short-term nature of these instruments, carrying valueapproximates their fair value.

 

***(e)******               ******Fair Value of FinancialInstruments***

 

The Company accounts forfinancial instruments that are being measured and reported on a fair valuebasis in accordance with ASC 820, *Fair Value Measurementsand Disclosures*.  ASC 820defines fair value, establishes a framework for measuring fair value andrequires enhanced disclosures about fair value measurements.  ASC 820 defines fair value as “the price thatwould be received to sell an asset or paid to transfer a liability in anordinary transaction between current market participants at the measurementdate”.

 

Fair value is generallybased on quoted market prices. If quoted market prices are not available, fairvalue is determined based on other relevant factors, including dealer pricequotations, price activity for equivalent instruments and valuation pricingmethods. Among the factors considered by the Company in determining the fairvalue of financial instruments for which there are no current quoted marketprices are credit spreads, the terms and liquidity of the instrument, thefinancial condition, operating results and credit ratings of the issuer orunderlying company, the quoted market price of publicly traded securities withsimilar duration and yield, assessing the underlying investments, market-basedinformation, such as comparable company transactions, performance multiples andchanges in market outlook as well as other measurements.  Financial instruments owned and financialinstruments sold, not yet purchased are stated at fair value, with relatedchanges in unrealized appreciation or depreciation reflected in principaltransactions, net in the accompanying consolidated statements of operations.Financial assets and financial liabilities carried at contract amounts mayinclude receivables from clearing brokers, securities purchased under resaleagreements, short-term borrowings and securities sold under repurchaseagreements. See Note 3 of the Notes to Consolidated Financial Statements foradditional discussion of ASC 820.

 

ASC 825, *Financial Instruments*, provides entities the option tomeasure certain financial assets and financial liabilities at fair value withchanges in fair value recognized in earnings each period.  ASC 825 permits the fair value option election,on an instrument-by-instrument basis, either at initial recognition of an assetor liability or upon an event that gives rise to a new basis of accounting forthat instrument.  Such election must beapplied to the entire instrument and not only a portion of the instrument.  The Company applied the fair value option forcertain eligible instruments, including all private equity securities andlimited partnership interests, as these financial instruments had beenaccounted for at fair value by the Company prior to the fair value optionelection in accordance with the ASC 940*, Financial Services —Broker and Dealers.*Generally, the fair values of these financialinstruments have been determined based on company performance and, in thoseinstances where market values are readily ascertainable, by reference to recentsignificant events occurring in the marketplace or quoted market prices. Duringthe fourth quarter of 2009, the Company elected to adopt the measurementamendments included in Accounting Standards Update (“ASU”) No. 2009-12, *Investments in Certain Entities That Calculate Net Asset Value perShare (or Its Equivalent)*(ASC 820). ASU No. 2009-12 permits, as a practical expedient, the use of thenet asset value per share, or its equivalent, of an entity to estimate its fairvalue. The Company’s partnership interests are recorded at fair value,determined by using net asset values or capital statements provided by thegeneral partner, updated for capital contributions and distributions andchanges in market conditions up to the reporting date.

 

***(f)******                 ******Securities Purchased UnderResale Agreements and Securities Sold Under Repurchase Agreements***

 

Securities purchased underresale agreements and securities sold under repurchase agreements are accountedfor as collateralized financing transactions. The assets and liabilities thatresult from these agreements are recorded in the consolidated

 

7

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

statements of financial condition at theamounts at which the securities were sold or purchased (contract value),respectively. It is the policy of the Company to obtain possession ofcollateral or deliver collateral, as the case may be, with a market value equalto or in excess of the principal amount of the transactions.  Collateral is valued daily, and the Companymay require counterparties to deposit additional collateral or returncollateral pledged when appropriate. Interest on securities purchased underresale agreements and securities sold under repurchase agreements is recognizedin interest and dividend income and interest expense, respectively, in theconsolidated statements of operations over the life of the transaction.

 

Therewere no resale or repurchase agreements outstanding as of March 31, 2010.

 

***(g)******              ******Receivables From ClearingBrokers***

 

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

 

***(h)******              ******Furniture, Equipment andLeasehold Improvements***

 

Furniture and equipment arecarried at cost and depreciated on a straight-line basis using estimated usefullives of the related assets, generally two to five years. Leaseholdimprovements are amortized on a straight-line basis over the lesser of theeconomic useful life of the improvement or the term of the respective leases.

 

***(i)******                 ******Revenue Recognition***

 

*Investment Banking*

 

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

 

Strategic advisory revenuesare recorded when earned, the fees are determinable and collection isreasonably assured. Non-refundable upfront fees are generally deferred andrecognized as revenue ratably over the expected period in which the relatedservices are rendered.  Upon successfulcompletion of a transaction or termination of an engagement, the recognition ofrevenue would be accelerated.

 

Capital markets revenueconsists of:

 

·      Underwritingrevenues, which are recognized on trade date, net of related syndicateexpenses, at the time the underwriting is completed. In syndicated underwrittentransactions, management estimates the Company’s share of transaction-relatedexpenses incurred by the syndicate, and the Company recognizes revenue net ofsuch expense. On final settlement, the Company adjusts these amounts to reflectthe actual transaction-related expenses and resulting underwriting fee.

 

·      Privateplacement revenues, which are recorded when the services related to theunderlying transaction are completed under the terms of the engagement.  This is generally the closing date of thetransaction.

 

Since the Company’sinvestment banking revenues are generally recognized at the time of completionof each transaction or when the services are performed, these revenuestypically vary between periods and may be considerably affected by the timingof the closing of significant transactions.

 

8

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

*Commissions*

 

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

 

*Principal transactions*

 

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

 

*Interest and dividend income*

 

The Company recognizescontractual interest on financial instruments owned at fair value on an accrualbasis as a component of interest and dividend income.** **Dividend income is recognized onthe ex-dividend date.

 

*Investment advisory fees*

 

The Company recognizesmanagement fees from managed funds over the period that the related service isprovided based upon a percentage of account balances, capital invested, capitalcommitments or some combination thereof. The Company also may be entitled to receive incentive fees based on apercentage of a fund’s return or when the return on assets under managementexceeds certain performance targets. Some incentive fees are based oninvestment performance over a 12-month period and are subject to adjustmentprior to the end of the measurement period. Accordingly, these incentive feesare recognized in the consolidated statements of operations when themeasurement period ends.

 

***(j)      Stock-Based Compensation***

 

Stock-based compensation ismeasured at fair value on the date of grant and amortized to compensationexpense over the requisite service period, net of estimated forfeitures.Stock-based awards that do not require future service (i.e., vested awards andawards granted to retirement eligible employees) are expensed immediately onthe date of grant.  Withholding taxobligations may be satisfied by the repurchase of shares by the Company.  Such shares are cancelled upon repurchase.

 

***(k)******              ******Income Taxes***

 

Deferred tax assets andliabilities are recognized for the future tax effect of differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferred taxassets and liabilities are measured using enacted tax rates.  The effect on deferred tax assets andliabilities of a change in tax rates is recognized in earnings in the periodthat includes the enactment date.  In theevent it is more likely than not that a deferred tax asset will not berealized, a valuation allowance is recorded.

 

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

 

***(l)******                 ******Earnings Per Common Share(“EPS”)***

 

Basic EPS is computed bydividing net income applicable to common shareholders, which represents netincome reduced by the allocation of earnings to participating securities, bythe weighted average number of common shares. Losses are not allocated to participating securities.  The weighted average number of common sharesoutstanding include restricted stock units for which no future service isrequired as a condition to the delivery of the underlying common stock.  Diluted EPS includes the determinants ofbasic EPS and, in addition, give effect to potentially dilutive common sharesrelated to Company stock compensation plans.

 

9

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

ASC 260, *Earnings Per Share*, addresses whether instruments granted inshare-based payment transactions are participating securities prior to vestingand therefore need to be included in the earnings allocation in calculating EPSunder the two-class method. Accordingly, the Company treats unvestedshare-based payment awards that have non-forfeitable rights to dividend ordividend equivalents as a separate class of securities in calculating EPS.

 

***(m)******           ******ForeignCurrency Translation***

 

The Company translates thestatements of financial condition of the Company’s foreign subsidiaries at theexchange rates in effect as of the end of each reporting period.  The consolidated statements of operations aretranslated at the average rates of exchange during the period. The resultingtranslation adjustments of the Company’s foreign subsidiaries are recordeddirectly to accumulated other comprehensive income (loss) in theconsolidated statements of changes in stockholders’ equity.

 

**(3)****        ****FinancialInstruments**

 

The Company accounts forfinancial instruments that are being measured and reported on a fair valuebasis in accordance with ASC 820.  Thisincludes those items currently reported in financial instruments owned, at fairvalue and financial instruments sold, not yet purchased, at fair value on theconsolidated statements of financial condition.

 

As defined in ASC 820, fairvalue is the price that would be received to sell an asset or paid to transfera liability in an orderly transaction between market participants at themeasurement date. In determining fair value, the Company uses various methods,primarily market and income approaches. Based on these approaches, the Companyutilizes assumptions that market participants would use in pricing the asset orliability, including assumptions about risk and/or the risks inherent in theinputs to the valuation technique. These inputs can be readily observable,market corroborated, or generally unobservable firm inputs. The Companyutilizes valuation techniques that maximize the use of observable inputs andminimize the use of unobservable inputs. Based on the observability of theinputs used in the valuation techniques, the Company is required to provide theinformation set forth below according to the fair value hierarchy. The fairvalue hierarchy ranks the quality and reliability of the information used todetermine fair values.   Financialinstrument assets and liabilities carried at fair value have been classifiedand disclosed in one of the following three categories:

 
| Level  1 |   | Quoted market prices in  active markets for identical assets or liabilities.                |
|---------------|--------|---------------------------------------------------------------------------------------------|
| Level  2 |   | Observable market based  inputs or unobservable inputs that are corroboratedby market data. |
| Level  3 |   | Unobservable inputs that  are not corroborated by market data.                              |

 

Level 1 primarily consistsof listed financial instruments whose value is based on quoted market prices,such as listed equities, options, warrants, and convertible preferredstock.  This category also may includeU.S. Government and agency securities for which the Company typically receivesindependent external valuation information. There were no transfers in or out of Level 1 during the three monthsended March 31, 2010.

 

Level 2 includes thosefinancial instruments that are valued using multiple valuation techniques,primarily the market approach.   Thevaluation methodologies utilized are calibrated to observable market inputs.  The Company considers recently executedtransactions, market price quotations and various assumptions, including creditspreads, the terms and liquidity of the instrument, the financial condition,operating results and credit ratings of the issuer or underlying company, thequoted market price of publicly traded securities with similar duration andyield, time value, yield curve, as well as other measurements. In order to beclassified as Level 2, substantially all of these assumptions would need to beobservable in the marketplace or can be derived from observable data orsupported by observable levels at which transactions are executed in themarketplace. Financial instruments in this category include certain corporatedebt, collateralized debt obligations (“CDOs”) primarily collateralized bybanking and insurance company trust preferred and capital securities, certainpreferred stock, convertible debt and residential mortgage-backedsecurities.  There were no transfers inor out of Level 2 during the three months ended March 31, 2010.

 

Fair value of corporatedebt, preferred stock, convertible debt and residential mortgage-backedsecurities classified as Level 2 was determined by using quoted market prices,broker or dealer quotes, or alternate pricing sources with reasonable levels ofprice transparency.  Fair value of CDOsprimarily collateralized by banking and insurance company trust preferred andcapital securities was determined primarily by considering recently executedtransactions of similar securities and certain assumptions, including the 

 

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

financial condition, operating results andcredit ratings of the issuer or underlying companies.

 

Level 3 is comprised offinancial instruments whose fair value is estimated based on multiple valuationtechniques, primarily market and income approaches. The valuation methodologiesutilized may include significant inputs that are unobservable from objectivesources. The Company considers various market inputs and assumptions, such as recentlyexecuted transactions, market price quotations, discount margins, marketspreads applied, the terms and liquidity of the instrument, the financialcondition, operating results and credit ratings of the issuer or underlyingcompany, the quoted market price of publicly traded securities with similarduration and yield, time value, yield curve, default rates, as well as othermeasurements.  Included in this categoryare certain corporate and other debt, including banking and insurance companytrust preferred, private equity securities and other investments includinglimited and general partnership interests.

 

Fairvalue of banking and insurance company trust preferred and capital securities classified as Level 3 was determined byprimarily utilizing a market spread method for each of the individualtrust preferred and capital securities utilizing credit spreads for secondarymarket trades for trust preferred and capital securities for issues which weresubstantially similar to such positions based on certain assumptions. The keymarket inputs in this method are the discount margins, market spreads applied,the yield expectations for similar instruments and the financial condition,operating results and credit ratings of the issuer or underlying company.

 

Fair value of private equitysecurities classified as Level 3 was determined by assessing market-basedinformation, such as performance multiples, comparable company transactions andchanges in market outlook. Fair value of limited and general partnership interestsclassified as Level 3 was determined by using net asset values or capitalstatements provided by the general partner, updated for capital contributionsand distributions and changes in market conditions up to the reporting date.  Private equity securities and limited andgeneral partnership interests generally trade infrequently.

 

The following table providesinformation related to financial instruments where a practical expedient wasused as the basis to measure the fair value of certain entities that calculatea net asset value per share (or equivalent) as of March 31, 2010:

 
| Type of Investment               |   | Fair Value |   | Unfunded  Commitments |   | Redemption Frequency |   | Redemption Notice  Period |   |
|----------------------------------|--------|------------|--------|-----------------------|--------|----------------------|--------|---------------------------|--------|
| Long/short hedge  funds (a)      | $      | 12,948     |   | $                     | — |                 |   | Monthly                   |   | 30 Days |   |
| Public/private  equity funds (b) |   | 32,144     |   |                  | 21,307 |                 |   | n/a                       |   | n/a |   |
|                             | $      | 45,092     |   | $                     | 21,307 |                 |   |                      |   |   |   |

 

(a)          This category includesinvestments in hedge funds that invest primarily in domestic long/shortpositions in equity securities and various derivatives, including options on securitiesand stock index options with respect to companies in the financial servicessector. Management of these funds also has the ability to invest in foreignequities and fixed income securities. The fair values of investments in thiscategory have been estimated using the net asset value per share, orequivalent, of the investments. Investments in this category can be redeemed monthly; however, thegeneral partner may impose a “gate” for any withdrawal over 20% of the totalfund net asset value.

 

(b)         This category includesseveral funds that invest primarily in domestic public and private companiesoperating in the financial services sector. Management of these funds also havethe ability to invest in foreign public and private equities, debt financialinstruments, warrants, hybrid securities and membership interests in thefinancial services sector. The fair values of investments in this category havebeen estimated using asset values based on capital statements provided by thegeneral partner, updated, as necessary, for capital contributions anddistributions and changes in market conditions up to the reporting date. Theseinvestments generally cannot be redeemed, unless approved by the generalpartners.  Upon liquidation of theunderlying investments prior to the life expectancy / maturity of the funds,management of the funds can elect to make distributions to the limitedpartners. The time horizon for such distributions is at the discretion of thegeneral partners but should not exceed the time horizon of the fund’s lifeexpectancy. It is estimated that these investments would be liquidatedapproximately ten years following the initial investment date, some withoptions to extend for up to a two year period, ranging from 2010 — 2020.  Additional expenses, such as legal andadministrative associated with the final liquidation can be incurred.Therefore, it is possible that upon final liquidation of the investments, thefinal funds distributed could be different from theestimated value of theinvestment.  However, these differencesare not expected to be material.

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

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

 

**Assetsat Fair Value as of March 31, 2010**

 
| ** **                                       | ** ** | **Level  1**              | ** ** | **Level  2** | ** **                | **Level  3** | ** ** | **Total**                 |
|--------------------------------------------------|------------|---------------------------|------------|--------------|---------------------------|--------------|------------|---------------------------|
| **Financial  instruments owned, at fair value:** |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Equities                                         | $          | 45,305                    |       | $            | 18                        |         | $          | 23,265                    |   | $ | 68,588 |   |
| Corporate and  other debt:                       |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Corporate debt                                   |       | -     |       |         | 46,883                    |         |       | 9,651                     |   |   | 56,534 |   |
| CDOs                                             |       | -     |       |         | 5,481                     |         |       | 1                         |   |   | 5,482 |   |
| Other debt  obligations(1)                       |       | -     |       |         | -     |         |       | 11,895                    |   |   | 11,895 |   |
| Total corporate  and other debt                  |       | -     |       |         | 52,364                    |         |       | 21,547                    |   |   | 73,911 |   |
| Mortgage-backed  securities - residential        |       | -     |       |         | 33,656                    |         |       | -     |   |   | 33,656 |   |
| Other  investments(2)                            |       | -     |       |         | -     |         |       | 45,092                    |   |   | 45,092 |   |
| Total  non-derivative trading assets             |       | 45,305                    |       |         | 86,038                    |         |       | 89,904                    |   |   | 221,247 |   |
| Equity  options/warrants                         |       | 13,224                    |       |         | -     |         |       | -     |   |   | 13,224 |   |
| **Total  financial instruments owned**           | $          | 58,529                    |       | $            | 86,038                    |         | $          | 89,904                    |   | $ | 234,471 |   |

 

(1) Consists of bank and insurance company trust preferred andcapital securities.

(2) Consists of limited and general partnership interests.

 

**Liabilitiesat Fair Value as of March 31, 2010**

 
| ** **                                                         | ** ** | **Level  1**              | ** ** | **Level  2** | ** **                | **Level  3** | ** ** | **Total**                 |
|--------------------------------------------------------------------|------------|---------------------------|------------|--------------|---------------------------|--------------|------------|---------------------------|
| **Financial  instruments sold, not yet purchased, at fair value:** |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Equities                                                           | $          | 45,071                    |       | $            | -     |         | $          | -     |   | $ | 45,071 |   |
| Corporate debt                                                     |       | -     |       |         | 2,408                     |         |       | -     |   |   | 2,408 |   |
| U.S. Government  and agency securities                             |       | 4,302                     |       |         | -     |         |       | -     |   |   | 4,302 |   |
| Total  non-derivative trading liabilities                          |       | 49,373                    |       |         | 2,408                     |         |       | -     |   |   | 51,781 |   |
| Equity  options/warrants                                           |       | 4,438                     |       |         | -     |         |       | -     |   |   | 4,438 |   |
| **Total  financial instruments sold, not yet purchased**           | $          | 53,811                    |       | $            | 2,408                     |         | $          | -     |   | $ | 56,219 |   |

 

12

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

**Assetsat Fair Value as of December 31, 2009**

 
| ** **                                       | ** ** | **Level  1**              | ** ** | **Level  2** | ** **                | **Level  3** | ** ** | **Total**                 |
|--------------------------------------------------|------------|---------------------------|------------|--------------|---------------------------|--------------|------------|---------------------------|
| **Financial  instruments owned, at fair value:** |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Equities                                         | $          | 40,197                    |       | $            | 22                        |         | $          | 15,873                    |   | $ | 56,092 |   |
| Corporate and  other debt:                       |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Corporate debt                                   |       | 9,354                     |       |         | 38,604                    |         |       | 10,000                    |   |   | 57,958 |   |
| CDOs                                             |       | -     |       |         | 5,448                     |         |       | 1                         |   |   | 5,449 |   |
| Other debt  obligations(1)                       |       | -     |       |         | -     |         |       | 12,347                    |   |   | 12,347 |   |
| Total corporate  and other debt                  |       | 9,354                     |       |         | 44,052                    |         |       | 22,348                    |   |   | 75,754 |   |
| Other  investments(2)                            |       | -     |       |         | -     |         |       | 41,917                    |   |   | 41,917 |   |
| Total  non-derivative trading assets             |       | 49,551                    |       |         | 44,074                    |         |       | 80,138                    |   |   | 173,763 |   |
| Derivative  financial instruments                |       | 628                       |       |         | -     |         |       | -     |   |   | 628 |   |
| **Total  financial instruments owned**           | $          | 50,179                    |       | $            | 44,074                    |         | $          | 80,138                    |   | $ | 174,391 |   |

 

(1) Consists of bank and insurance company trust preferred andcapital securities.

(2) Consists of limited and general partnership interests.

 

**Liabilitiesat Fair Value as of December 31, 2009**

 
| ** **                                                         | ** ** | **Level  1**              | ** ** | **Level  2** | ** **                | **Level  3** | ** ** | **Total**                 |
|--------------------------------------------------------------------|------------|---------------------------|------------|--------------|---------------------------|--------------|------------|---------------------------|
| **Financial  instruments sold, not yet purchased, at fair value:** |       |                      |       |         |                      |         |       |                      |   |   |   |   |
| Equities                                                           | $          | 31,191                    |       | $            | -     |         | $          | -     |   | $ | 31,191 |   |
| Corporate debt                                                     |       | -     |       |         | 4,723                     |         |       | -     |   |   | 4,723 |   |
| U.S. Government  and agency securities                             |       | 962                       |       |         | -     |         |       | -     |   |   | 962 |   |
| Total  non-derivative trading liabilities                          |       | 32,153                    |       |         | 4,723                     |         |       | -     |   |   | 36,876 |   |
| Derivative  financial instruments                                  |       | 97                        |       |         | -     |         |       | -     |   |   | 97 |   |
| **Total  financial instruments sold, not yet purchased**           | $          | 32,250                    |       | $            | 4,723                     |         | $          | -     |   | $ | 36,973 |   |

 

The non-derivative trading assets/liabilitiescategories were reported in financial instruments owned, at fair value andfinancial instruments sold, not yet purchased, at fair value on the Company’sconsolidated statements of financial condition.

 

The derivative financial instruments were reported ona gross basis by level. The Company’s derivative activities included infinancial instruments owned and financial instruments sold, not yet purchasedconsist of writing and purchasing listed equity options and warrants.

 

13

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Tableof Contents

 

**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

The following table provides a reconciliation of thebeginning and ending balances for the non-derivative trading assets measured atfair value using significant unobservable inputs (Level 3) for the three monthsended March 31, 2010 and 2009:

 

**Level 3 Financial Assets**

 
| ** **                      | ** ** | **Balance  as of  December 31, 2009** | ** ** | **Total  gains  and (losses)  (realized and  unrealized)** | ** ** | **Purchases/  (sales), net** | ** ** | **Transfers  in (out)  of Level 3** | ** ** | **Balance  as of  March 31, 2010** | ** ** | **Changes  in  unrealized gains and  (losses) included in  earnings related to  assets still held at  reporting date** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|
| Equities                        |       | $15,873                                    |       | $27                                                        |       | $7,365                       |       | $-                                  |       | $23,265                                 |       | $27                                                                                                                    |
| Corporate and  other debt:      |       |                                       |       |                                                       |       |                         |       |                                |       |                                    |       |                                                                                                                   |
| Corporate debt                  |       | 10,000                                     |       | (349)                                                      |       | -                            |       | -                                   |       | 9,651                                   |       | (349)                                                                                                                  |
| CDOs                            |       | 1                                          |       | -                                                          |       | -                            |       | -                                   |       | 1                                       |       | -                                                                                                                      |
| Other debt  obligations         |       | 12,347                                     |       | (452)                                                      |       | -                            |       | -                                   |       | 11,895                                  |       | (452)                                                                                                                  |
| Total corporate  and other debt |       | 22,348                                     |       | (801)                                                      |       | -                            |       | -                                   |       | 21,547                                  |       | (801)                                                                                                                  |
| Other investments               |       | 41,917                                     |       | 1,828                                                      |       | 1,347                        |       | -                                   |       | 45,092                                  |       | 1,828                                                                                                                  |
| Total Level 3  financial assets |       | $80,138                                    |       | $1,054                                                     |       | $8,712                       |       | $-                                  |       | $89,904                                 |       | $1,054                                                                                                                 |
|                            |       |                                       |       |                                                       |       |                         |       |                                |       |                                    |       |                                                                                                                   |
| ** **                      | ** ** | ** **                                 | ** ** | ** **                                                 | ** ** | ** **                   | ** ** | ** **                          | ** ** | ** **                              | ** ** | ** **                                                                                                             |
| ** **                      | ** ** | **Balance  as of  December 31, 2008** | ** ** | **Total  gains  and (losses)  (realized and  unrealized)** | ** ** | **Purchases/  (sales), net** | ** ** | **Transfers  in (out)  of Level 3** | ** ** | **Balance  as of  March 31, 2009** | ** ** | **Changes  in  unrealized gains and  (losses) included in  earnings related to  assets still held at  reporting date** |
|                            |       |                                       |       |                                                       |       |                         |       |                                |       |                                    |       |                                                                                                                   |
| Non-derivative  trading assets  |       | $82,303                                    |       | ($5,030)                                                   |       | $1,139                       |       | $764                                |       | $79,176                                 |       | ($5,232)                                                                                                               |

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

Total gains and lossesrepresent the total gains and/or losses (realized and unrealized) recorded forthe Level 3 assets and were reported in principal transactions, net in theaccompanying consolidated statements of operations. Additionally, the change inthe unrealized gains and losses may be offset by realized gains and lossesduring the period.

 

Purchases/sales representthe net amount of Level 3 assets that were either purchased or sold during theperiod. The amounts were recorded at their end of period fair values.

 

Transfers in/out of Level 3represent existing financial assets that were previously categorized at a lowerlevel.  Transfers in or out of Level 3 result from changes in theobservability of inputs used in determining fair values for different types offinancial assets.  Transfers were reported at their fair value as of theactual date in which such changes in the fair value inputs occurs.

 

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

 

**(4)****        ****Short-TermBorrowings**

 

From time to time, theCompany obtains secured short-term borrowings primarily through bankloans.  At March 31, 2010 and December 31,2009, there were no short-term borrowing obligations outstanding.

 

**(5)****        ****Commitmentsand Contingencies**

 

***(a)******              ******Leases***

 

As of March 31, 2010,there were no significant changes in the Company’s lease agreements since December 31,2009.

 

***(b)******              ******Litigatio*****n**

 

In the ordinary course ofbusiness, the Company may be a defendant or codefendant in legalproceedings.  At March 31, 2010, theCompany believes, based on currently available information, that the results ofsuch proceedings, in the aggregate, will not have a material adverse effect onthe Company’s financial condition. The results of such proceedings could bematerial to the Company’s operating results for any particular period, depending,in part, upon additional developments affecting such matters and the operatingresults for such period. Legal reserves have been established in accordancewith ASC 450, *Contingencies*. Once established,reserves are adjusted when there is more information available or when an eventoccurs requiring a change.

 

*SentinelManagement Group Litigation*

 

On January 12, 2009,Frederick J. Grede, as Liquidation Trustee and Representative of the Estate ofSentinel Management Group, Inc. (“Sentinel”), filed a lawsuit in theUnited States District Court for the Northern District of Illinois againstKeefe and against Delores E. Rodriguez; Barry C. Mohr, Jr.; and Jacques DeSaint Phalle (all former employees of Keefe) and Cohen & CompanySecurities, LLC.  Ms. Rodriguez and Mr. Mohrwere employed by Cohen & Company subsequent to being employed by Keefeand the complaint relates to activities by them at both Keefe and theirsubsequent employer.

 

The complaint alleges thatKeefe recommended and sold to Sentinel Management Group structured financeproducts that were unsuitable for purchase. The complaint alleges the following causes of action against Keefe,aiding and abetting breach of fiduciary duty by an officer and director of Sentinel;commercial bribery; violations of federal and state securities laws; violationof the Illinois Consumer Fraud Act; negligence; unjust enrichment; andavoidance and recovery of fraudulent transfers. The complaint specifies that Sentinel sustained a loss associated withthe sale of securities sold by Keefe of $4,920, and interrogatory responsesfrom the Trustee in discovery now contend that Sentinel lost $5,629; howevervarious causes of action in the complaint seek to recover amounts substantiallyin excess of that amount up to an amount in excess of $130,000, representingamounts paid for all securities purchased from Keefe regardless of suitabilityor whether there were losses on these securities.  Keefe believes the claims are without meritand will defend these claims vigorously. On April 1, 2009, Keefe filed aMotion to Dismiss the Complaint.  On July 29,2009, the court denied most of the relief sought in Keefe’s Motion to Dismiss,though it dismissed the Illinois Consumer Fraud Act claim 

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

and granted Keefe’s motion to sever theTrustee’s case against Keefe from the case against Cohen.  On August 26, 2009, Keefe filed aThird-Party Complaint against Eric A. Bloom, the former President and CEO ofSentinel, and Charles K. Mosley, the former Senior Vice President and headtrader of Sentinel, alleging fraud and seeking contribution for any damages forwhich Keefe is held liable to the Trustee.  The court stayed and severedthis Third-Party Complaint on October, 7, 2009.

 

On May 21, 2009 theTrustee filed an additional complaint in the same court and against the sameparties (the “Second Complaint”).  TheTrustee claimed to be acting in the Second Complaint in his capacity asliquidation trustee and as an assignee of claims of Sentinel’s customers.  The Second Complaint makes substantially thesame allegations as the complaint described above.  Keefe believes the claims in the SecondComplaint are also without merit and will defend these claims vigorously.  On July 28, 2009, in *Grede v. Bank of New York Mellon* et al filed in the samecourt, in which the Trustee alleged similar customer claims as an assignee, thecourt dismissed the Trustee’s claims due to lack of standing.  The Trustee has appealed the court’sdismissal of *Grede v. Bank of New York Mellon*and, on August 19, 2009, the court stayed the Second Complaint while theTrustee’s appeal in *Grede v. Bank of New YorkMellon* is pending.   On March 18,2010, the Seventh Circuit reversed the district court, holding that the Trusteehad standing to pursue the assigned customer claims against Bank of New YorkMellon.  Currently, the Second Complaintremains stayed, pending the possibility of further appellate review in *Grede v. Bank of New York Mellon*, including en banc reviewby the Seventh Circuit and/or review by the Supreme Court.

 

*MidFirstBank Litigation*

 

OnDecember 6, 2007, MidFirst Bank (“MidFirst”) filed a lawsuit against Keefein the Federal District Court for the Western District of Oklahoma, in anaction captioned *MidFirst Bank v. Keefe, Bruyette &Woods, Inc.,* Case No. 07-CV-1384-R (W.D. Oklahoma.).  The complaint arises out of MidFirst’sinvestment in subordinated trust certificates, which Keefe solicited MidFirstto acquire in early 2007.  MidFirstacquired the securities for approximately $5,000.  During the fall of 2007, in connection withthe failure of the global markets, MidFirst’s investment declined invalue.  MidFirst sued Keefe, claimingthat Keefe misrepresented the terms of the securities.  MidFirst initially alleged that Keefe violatedSection 10(b) of the Exchange Act, the Oklahoma Uniform SecuritiesAct, committed common law fraud and negligent misrepresentation.   Keefe moved to dismiss and the Court grantedthe motion to dismiss the Section 10(b) claim which was notrepleaded.  Based on its state lawclaims, MidFirst is seeking a rescission of approximately $5,100 incompensatory damages and an unspecified sum for punitive damages and attorney’sfees or in the alternative damages of approximately $2,400.

 

Keefeanswered the complaint and brought a third-party complaint against WachoviaCapital Markets LLC (“Wachovia”), which solicited Keefe to sell thesesecurities and which knew Keefe was purchasing them for resale to acustomer.  Keefe’s claims againstWachovia are for contribution and indemnity, common law fraud and negligentmisrepresentation.  Wachovia has answeredthe third-party complaint, denying all material allegations.

 

Theparties are in the discovery process of this litigation and the case iscurrently scheduled for trial commencing in August 2010. Keefe has beenand is continuingto defendagainst the MidFirst suit and prosecuting Keefe’s claims against Wachoviavigorously.

 

***(c)******               ******Investment Commitments***

 

As of March 31, 2010,the Company had approximately $21,307, including $9,588 to an affiliated fund,in outstanding commitments for additional funding to limited partnershipinvestments.

 

**(6)****        ****FinancialInstruments with Off-Balance-Sheet Risk**

 

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

 

Also, in connection with itsprincipal trading activities, the Company has sold securities that it does notcurrently own and will, therefore, be obligated to purchase such securities ata future date. The Company has recorded this obligation in the financial 

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

statements at market values of the relatedsecurities and will record a trading loss if the market value of the securitiesincreases subsequent to the consolidated financial statements date.

 

***(a)******              ******Broker-Dealer Activities***

 

The Company clearssecurities transactions on behalf of customers through its clearing brokers. Inconnection with these activities, customers’ unsettled trades may expose theCompany to off-balance-sheet credit risk in the event customers are unable tofulfill their contracted obligations. The Company seeks to control the riskassociated with its customer activities by monitoring the creditworthiness ofits customers.

 

***(b)******              ******Derivative Financial Instruments***

 

The Company’s derivativeactivities consist of writing and purchasing listed equity options and/orwarrants and, from time to time, futures on interest rate, currency and equityproducts and mortgage-backed TBA securities for trading for our own account.  Options and warrants are included infinancial instruments owned, at fair value and financial instruments sold, notyet purchased, at fair value in the accompanying consolidated statements offinancial condition. See also Note 3 of the Notes to Consolidated Financial Statementsfor additional details. As a writer of options, the Company receives a cashpremium at the beginning of the contract period and bears the risk ofunfavorable changes in the fair value of the financial instruments underlyingthe options. Options written do not expose the Company to credit risk sincethey obligate the Company (not its counterparty) to perform.

 

In order to measurederivative activity, notional or contract amounts are frequently utilized.Notional contract amounts, which are not included on the consolidatedstatements of financial condition, are used as a basis to calculate contractualcash flows to be exchanged and generally are not actually paid or received.

 

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

 

| ** **                             | ** ** | **Current**  | ** ** | **Average** |       | **End of**     |
|----------------------------------------|------------|--------------|------------|-------------|------------|----------------|
| ** **                             | ** ** | **Notional** | ** ** | **Fair**    | ** ** | **Period**     |
| ** **                             | ** ** | **Value**    | ** ** | **Value**   | ** ** | **Fair Value** |
| March 31, 2010:                   |       |         |       |        |       |           |
| Purchased  options/warrants            |       | $            | 35,916     |        | $          | 6,492          |   | $ | 13,224 |
| Written options                        |       | $            | 22,415     |        | $          | 2,118          |   | $ | 4,438 |
| Short futures contracts                |       | $            | 5,792      |        | $          | -              |   | $ | - |
| Agency  mortgage-backed TBA securities |       | $            | 20,300     |        | $          | 14             |   | $ | 44 |
|                                   |       |         |       |        |       |           |
| December 31, 2009:                |       |         |       |        |       |           |
| Purchased  options/warrants            |       | $            | 8,285      |        | $          | 380            |   | $ | 628 |
| Written options                        |       | $            | 630        |        | $          | 511            |   | $ | 97 |
| Short futures  contracts               |       | $            | 6,136      |        | $          | -              |   | $ | - |

 

The following table summarizesthe net gains from trading activities included in principal transactions, netwith respect to the consolidated statements of operations for the period ended March 31,2010:

 

| **Type  of Instrument**    |   | **Principal  Transactions, Net** |
|----------------------------|--------|----------------------------------|
| Equities                   | $      | 5,051                            |
| Corporate and other debt   |   | 8,831                            |
| Mortgage-backed securities |   | 3,337                            |
| Other investments          |   | 1,828                            |
| Total                      | $      | 19,047                           |

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

The revenue related to theequities and mortgage-backed securities categories included realized andunrealized gains and losses on both derivative instruments and non-derivativeinstruments. Corporate and other debt and other investments included realizedand unrealized gains and losses on non-derivative instruments.

 

**(7)****        ****Concentrationsof Credit Risk**

 

The Company is engaged invarious securities trading and brokerage activities servicing primarilydomestic and foreign institutional investors. Nearly all of the Company’stransactions are executed with and on behalf of institutional investors,including other brokers and dealers, commercial banks, mutual funds, and otherfinancial institutions. The Company’s exposure to credit risk associated withthe non-performance of these customers in fulfilling their contractualobligations pursuant to securities transactions can be directly impacted byvolatile securities markets.

 

A substantial portion of theCompany’s marketable securities are common stock and debt of financialinstitutions. The credit and/or market risk associated with these holdings canbe directly impacted by factors that affect this industry such as volatileequity and credit markets and actions of regulatory authorities.

 

**(8)****        ****NotesReceivable from Stockholders**

 

Notes receivable fromstockholders represent full recourse notes issued to employees for their purchasesof stock acquired pursuant to the Company’s book value stock purchase plan.Loans are payable in annual installments and bear interest of 5.0% per annum.

 

**(9)****        ****Stock-Basedand Other Incentive Compensation**

 

*Stock-Based Compensation*

 

At March 31, 2010, the Company had one effectivestock-based compensation arrangement under the 2009 Incentive Compensation Plan(the “Plan”).  As part of the 2009year-end performance award process (“2009 Bonus Awards”), the Company granted1,344,042 restricted stock awards (“RSAs”) under the Plan to certain employeesin February 2010. The aggregate fair value of the RSAs granted inconnection with the 2009 Bonus Awards in February 2010 was $35,321.  This value was based upon the grant dateshare price of $26.28. RSAs are actual shares of common stock issued to theparticipant that are restricted.   Thestock granted in connection with the 2009 Bonus Awards generally vests over athree year period. Vesting would accelerate on a change in control, death orpermanent disability. Unvested RSAs are subject to forfeiture upon terminationof employment and in certain circumstances failing to meet performancecriteria.

 

For 2009 Bonus Awards that were granted toretirement-eligible employees, the Company recognized the grant date fair valueas compensation expense for such awards on the date of grant instead of overthe service period specified in the award terms. For employees who will beretirement-eligible prior to vesting of the 2009 Bonus Awards, the Companyrecognizes compensation expense ratably from the grant date to the retirementeligibility date. The Company recorded accelerated non-cash incrementalcompensation expense of $4,824 in the first quarter of 2010 related to 2009Bonus Awards granted to retirement-eligible employees (including employees whowill be retirement-eligible prior to vesting).

 

*Long Term Incentive Program*

 

In February 2010, the Company adopted a Long TermIncentive Program (the “LTIP”) under the Plan. The LTIP allows the Company to make awards under the Plan to selectedemployees, which awards will provide for payments of such amounts pursuant tosuch terms and conditions as the Company shall determine.  The LTIP provides that amounts specified orcalculated pursuant to awards may be earned during a performance cycleestablished for such an award upon the achievement of specified performancegoals.

 

During the first quarter of 2010, the Company approvedawards under the Plan to three employees. The LTIP awards have established performance cycles and amounts payablebased on achieving specific performance criteria during the performance cycle.

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

**(10)**** ****EarningsPer Share**

 

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

 
|                                                                    | ** ** | **Three  Months Ended**   |
|-------------------------------------------------------------------------|------------|---------------------------|
|                                                                    | ** ** | **March 31,**        |
|                                                                    | ** ** | **2010**                  | ** ** | **2009** |
|                                                                    |       |                      |   |   |
|                                                                    |       |                      |   |   |
| **Net income**                                                          | $          |                      | 11,621 | $ |   | 730 |
| **Less:  Allocation of earnings to participating  securities**     |       | 1,258                     |   | 85 |
| **Net income applicable to common  shareholders**                       | $          |                      | 10,363 | $ |   | 645 |
|                                                                    |       |                      |   |   |
| **Weighted average number of common  share outstanding****(1)(2)****:** |       |                      |   |   |
| Basic                                                                   |       | 32,240,838                |   | 31,354,507 |
| Effect of  dilutive securities - restricted stock                       |       | -     |   | -     |
| Diluted                                                                 |       | 32,240,838                |   | 31,354,507 |
|                                                                    |       |                      |   |   |
| **Earnings per common share****(1)(2)****:**                            |       |                      |   |   |
| Basic                                                                   | $          |                      | 0.32 | $ |   | 0.02 |
| Diluted                                                                 | $          |                      | 0.32 | $ |   | 0.02 |

 

(1) Participating securities in the form ofunvested share based payment awards amounted to weighted average shares of3,914,573 and 4,108,919 for the three months ended March 31, 2010 and2009, respectively.

 

(2) Basic and diluted common sharesoutstanding were equal for the periods presented under the two-class method.

 

**(11)**** ****IncomeTaxes**

 

The Company applies the provisions of ASC 740, whichprescribes the recognition and measurement criteria related to tax positionstaken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must bemore-likely-than-not to be sustained upon examination by taxingauthorities.  In addition, the followinginformation required by ASC 740 is provided:

 

·                  The Company’s gross unrecognizedtax benefits, excluding interest, have not changed significantly since December 31,2009.

 

·                  TheCompany classifies interest and penalties, if any, related to tax uncertaintiesas income tax expenses.   As of March 31, 2010, this amount hadnot changed significantly since December 31, 2009.

 

·                  TheCompany and its subsidiaries file federal consolidated and various state, localand foreign tax returns.  The federal income tax returns have been auditedthrough 2005.  Various state, local and foreign returns are subject toaudits by tax authorities beginning with the 2002 tax year.  Thesettlement of certain state and local audits within the next 12 months, if any,is not anticipated to have a significant impact on the Company’s results orfinancial position.

 

**(12)**** ****Industry Segment Data**

 

The Company follows the provisions of ASC 280, *Segment Reporting*, in disclosing its business segments.Pursuant to that statement, an entity is required to determine its businesssegments based on the way management organizes the segments within theenterprise for making operating decisions and assessing performance. Based uponthese criteria, the Company has determined that its entire business should beconsidered a single segment.

 

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**KBW, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements — (Continued)**

**(unaudited)**

**(Dollarsin thousands, except per share information)**

 

**(13)**** ****Net Capital Requirement**

 

Keefe is a registered U.S. broker-dealer that issubject to the Uniform Net Capital Rule (SEC Rule 15c3-1 or the NetCapital Rule) administered by the SEC and FINRA, which requires the maintenanceof minimum net capital. Keefe has elected to use the basic method to computenet capital as permitted by the Net Capital Rule, which requires Keefe tomaintain minimum net capital, as defined, of $3,411 as of March 31, 2010.These rules also require Keefe to notify and sometimes obtain approvalfrom FINRA for significant withdrawals of capital.

 
| ** **  | ** ** | **March 31,  2010** |
|-------------|------------|--------------------------|
| Net Capital |       | $                        | 107,265 |
| Excess      |       | $                        | 103,854 |

 

KBWL is an investment firm authorized and regulated bythe FSA in the United Kingdom and is subject to the capital requirements of theFSA. As of March 31, 2010, KBWL was in compliance with its local capitaladequacy requirements.  At March 31,2010, KBWL’s capital resources of approximately $34,222 exceeded the capitalresources requirement by approximately $24,436.

 

**(14)**** ****Recent Accounting Developments**

 

In January 2010, FASB issued ASU No. 2010-06*, Fair Value Measurements and Disclosures (Topic 820): ImprovingDisclosures about Fair Value Measurements.*  ASU No. 2010-06 requires additional fairvalue measurement disclosure requirements and clarifies certain existingdisclosure requirements. The additional disclosures include significanttransfers in and out of Level 1 and Level 2 fair value measurements, andreasons for the transfers, and activity in Level 3 fair valuemeasurements.  ASU No. 2010-06 iseffective for interim and annual periods beginning after December 15,2009, except for the disclosures on the activity in Level 3 fair value measurements,which is effective for interim and annual periods beginning after December 15,2010. In January 2010, the Company adopted ASU No. 2010-06, exceptfor the disclosure requirements related to the activity in Level 3 fair valuemeasurements.

 

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**Item 2.*   *Management’s Discussion and Analysis of FinancialCondition and Results of Operations**.

 

*Thefollowing discussion should be read in conjunction with our unauditedconsolidated financial statements and the related notes included elsewhere inthis report.*

 

**Cautionary Statement RegardingForward Looking Statements**

 

We have made statements in “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and in othersections of this report that are forward-looking statements. In some cases, youcan 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 othercomparable terminology. These forward-looking statements, which are based onvarious underlying assumptions and expectations and are subject to risks,uncertainties and other unknown factors, may include projections of our futurefinancial performance based on our growth strategies and anticipated trends inour business. These statements are only predictions based on our current expectationsand projections about future events. There are or may be important factors thatcould cause our actual results, level of activity, performance or achievementsto differ materially from the historical or future results, level of activity,performance or achievements expressed or implied by such forward-lookingstatements. These factors include, but are not limited to, those discussed inthe section entitled “Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2009.

 

Although we believe the expectations reflected in theforward-looking statements are reasonable, we cannot guarantee future results,level of activity, performance or achievements. Moreover, neither we nor anyother person assumes responsibility for the accuracy or completeness of any ofthese forward-looking statements. You should not rely upon forward-lookingstatements as predictions of future events. We are under no duty to update anyof these forward-looking statements after the date of filing of this report toconform such statements to actual results or revised expectations.

 

**Overview**

 

We are a full service investment bank specializing inthe financial services industry. Our principal activities are:  (i) investment banking, includingmergers and acquisitions (“M&A”) and other strategic advisory services,equity and fixed income securities offerings, and mutual thrift conversions, (ii) equityand fixed income sales and trading, (iii) research that providesfundamental, objective analysis that identifies investment opportunities andhelps our investor customers make better investment decisions, and (iv) assetmanagement, including investment management and other advisory services toinstitutional clients and private high net worth clients and various investmentvehicles.

 

Within our full service business model, our focusincludes bank and thrift holding companies, banking companies, thriftinstitutions, insurance companies, broker-dealers, mortgage banks, assetmanagement companies, mortgage and equity real estate investment trusts,consumer and specialty finance firms, financial processing companies andsecurities exchanges.  We emphasizeserving investment banking clients in the small and mid cap segments of thefinancial services industry although our clients also include many large-capcompanies.  Our sales customers areprimarily institutional investors.

 

Most revenues with respect to our services providedare primarily determined as a result of active competition in the marketplace.Our revenues are primarily generated through advisory, underwriting and privateplacement fees earned through our investment banking activities, commissionsearned on equity sales and trading activities, interest and dividends earned onour securities’ inventories and profit and losses from trading activitiesrelated to the securities’ inventories.

 

Our largest expense is compensation and benefits.  Our performance is dependant on our abilityto attract, develop and retain highly skilled employees who are motivated toprovide quality service and guidance to our clients.

 

Many external factors affect our revenues andprofitability. Such factors include equity and fixed income trading prices andvolumes, the volatility of these markets, the level and shape of the yieldcurve, political events and regulatory developments, and competition. Thesefactors influence our investment banking operations in that such factors affectthe number and timing of equity and fixed income securities issuances andM&A activity within the financial services industry. These same factorsalso affect our sales and trading business by impacting equity and fixed incometrading prices and volumes and valuations in secondary financial markets.Commission rates, market volatility and other factors also affect our sales andtrading revenues. These market forces may cause our revenues and earnings tofluctuate significantly from period to period and the results of any one periodshould not be considered indicative of future results.  See “—Business Environment.”

 

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A significant portion of our expense base is variable,including employee compensation and benefits, brokerage and clearance,communication and data processing and business development expenses. Ourremaining costs generally do not directly relate to the service revenuesearned.

 

Certain data processing systems that support equityand fixed income trading, research, payroll, human resources and employeebenefits are service bureau based and are operated in the vendors’ datacenters. We believe that this stabilizes our fixed costs associated with dataprocessing. We also license vendor information databases to support investmentbanking, sales and trading and research. Vendors may, at the end of contractualterms, terminate our rights or modify or significantly alter product andservice offerings or related fees, which may affect our ongoing businessactivities or related costs.

 

**Business Environment**

 

Our business activities focus on the financialservices sector, the landscape of which, in the U.S. and globally, hascontinued to evolve since the global financial crisis began in 2007.  In the U.S. there has been some return ofmarket confidence in this sector and very strong activity in capital markets’transactions, as selected companies have recapitalized following the completionby U.S. bank regulators of the Supervisory Capital Assessment Program, whichprovided markets with a uniform approach for estimating loan losses in valuingU.S. bank stocks.  Since the firstquarter of 2009, the equity value of the U.S. financial sector has increaseddramatically, which trend accelerated since the beginning of 2010.   Many institutions have positioned themselvesto take advantage of acquisition opportunities that may develop, in some caseswith government assistance.  We continuedto be very active in capital markets transactions, participating in 24 equitycapital raises for the first quarter in 2010. However, the sector remains under stress and the market stability andcontinuation of current trends is not certain. The valuation of certain classes of assets remains uncertain and thereare continuing concerns in the credit quality of multiple asset classes,especially commercial real estate. Securitization markets have not broadly reopened.  U.S. unemployment remains high and lenderscontinue to lend only to the most credit worthy borrowers, making credit tightacross the broad economy.

 

In the U.S., the financial services sector remainshighly fragmented.  There areapproximately 1,020 publicly traded banks and thrifts and approximately 7,930different banking entities in the U.S. Because of our focus, we are particularly impacted by economic andmarket conditions affecting this sector. Although many larger financial institutions have succeeded inrecapitalizing and have repaid government assistance, bank failures amongsmaller institutions have continued.  Inthe first quarter of 2010,  there were 41failed U.S. banks with assets totaling $19.7 billion compared to 21 failedbanks in the U.S. with assets totaling $5.5 billion in the first quarter of2009.  Trends in the global economy anddomestic and international financial markets have a significant impact on theoutlook for financial services, including the market prices for our stock andthe securities of other companies in the sector.

 

Globally, there continues to be some stress in Europewith a bailout of sovereign debt for Greece posing challenges for the economiesof other European countries putting stress on European financial markets.

 

It is difficult to predict how long these conditionswill continue or whether additional deteriorations in asset quality, furthercredit market dislocations or sustained market downturns may exacerbate theimpact of these factors on our overall revenues.   Even with increasing market stabilization inrecent quarters, there has not been a significant return of M&Aactivity.  During 2009 and in the firstquarter of 2010, many financial institutions have reported operatingprofitability, although others reportedsignificant losses, in particular resulting from increases to loan lossreserves.  There are proposals inCongress to substantially change the regulation of the banking sector,including proposals to impose limitations on certain activities by bankingentities.  Even if enacted, these laws will requiresubstantial rulemaking prior to implementation, and the impact on our industryand on many of our clients and customers cannot currently be predicted.  We believe that we are well capitalized andremain well positioned to assist in capital markets and M&A transactionsfor the financial services industry in both the U.S. and Europe.

 

**Resultsof Operations**

 

***Three Months Ended March  31, 2010 Compared withThree Months Ended March 31, 2009***

 

*Overview*

 

Total revenues increased$61.0 million, or 84.4%, to $133.3 million for the three months ended March 31,2010, compared with $72.3 million for the three months ended March 31,2009. This increase was primarily due to record investment banking revenues of$70.0 million for the three months ended March 31, 2010, an increase of$43.1 million compared with the three months ended March 31, 2009.  In addition, principal transactions, netincreased $14.9 million compared with the three months ended March 

 

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31, 2009.

 

Total expenses were$113.0 for the three months ended March 31, 2010 compared with $70.3 forthe three months ended March 31, 2009. The increase was due to a $36.2 million increase in compensation andbenefits expense, reflecting higher revenues, and a $6.4 million increase innon-compensation expenses.

 

We recorded net income of$11.6 million, or $0.32 per diluted share, for the three months ended March 31,2010, compared with $0.7 million, or $0.02 per diluted share, for the sameperiod in 2009. After adjusting for the 2006 one-time restricted stock awardsgranted to employees in connection with our initial public offering (“IPO”),our non-GAAP operating net income was $13.1 million, or $0.36 per diluted sharefor the three months ended March 31, 2010, compared with $1.6 million, or$0.05 per diluted share for the same period in 2009. See “-Non-GAAPFinancial Measures” for a reconciliation of our non-GAAP measures to theircorresponding GAAP amounts.

 

The following tableprovides a comparison of our revenues and expenses for the periods presented(dollars in thousands):

 
|                                | ** ** | **Three  Months Ended** | ** ** | ** **            | ** ** |              |       |          |       |
|-------------------------------------|------------|-------------------------|------------|-----------------------|------------|-------------------|------------|---------------|------------|
|                                | ** ** | **March 31,**      | ** ** | **Period  to Period** |       |
|                                | ** ** | **2010**                | ** ** | **2009**              | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                          | ** ** | **(unaudited)**         |       |
| **Revenues:**                       |       |                    |       |                  |       |              |       |          |       |   |   |   |   |
| Investment  banking                 | $          |                    | 69,962     |                  | $          |              | 26,860     |          | $          |   | 43,102 |   |   | 160.5 |   | % |
| Commissions                         |       | 35,404                  |       |                  | 36,019     |              |       | (615          | )          |   | (1.7 | ) |   |
| Principal  transactions, net        |       | 19,047                  |       |                  | 4,116      |              |       | 14,931        |       |   | 362.8 |   |   |
| Interest and  dividend income       |       | 2,884                   |       |                  | 1,738      |              |       | 1,146         |       |   | 65.9 |   |   |
| Investment  advisory fees           |       | 294                     |       |                  | 313        |              |       | (19           | )          |   | (6.1 | ) |   |
| Other                               |       | 5,719                   |       |                  | 3,230      |              |       | 2,489         |       |   | 77.1 |   |   |
| **Total  revenues**                 |       | 133,310                 |       |                  | 72,276     |              |       | 61,034        |       |   | 84.4 |   |   |
| **Expenses:**                       |       |                    |       |                  |       |              |       |          |       |   |   |   |   |
| Compensation and  benefits          |       | 81,878                  |       |                  | 45,667     |              |       | 36,211        |       |   | 79.3 |   |   |
| Occupancy and  equipment            |       | 5,612                   |       |                  | 5,159      |              |       | 453           |       |   | 8.8 |   |   |
| Communications  and data processing |       | 7,656                   |       |                  | 6,660      |              |       | 996           |       |   | 15.0 |   |   |
| Brokerage and  clearance            |       | 5,086                   |       |                  | 3,882      |              |       | 1,204         |       |   | 31.0 |   |   |
| Business  development               |       | 3,460                   |       |                  | 3,032      |              |       | 428           |       |   | 14.1 |   |   |
| Interest                            |       | 258                     |       |                  | 169        |              |       | 89            |       |   | 52.7 |   |   |
| Other                               |       | 9,050                   |       |                  | 5,777      |              |       | 3,273         |       |   | 56.7 |   |   |
| Non-compensation  expenses          |       | 31,122                  |       |                  | 24,679     |              |       | 6,443         |       |   | 26.1 |   |   |
| **Total  expenses**                 |       | 113,000                 |       |                  | 70,346     |              |       | 42,654        |       |   | 60.6 |   |   |
| **Income  before income taxes**     |       | 20,310                  |       |                  | 1,930      |              |       | 18,380        |       |   | 952.3 |   |   |
| **Income  tax expense**             |       | 8,689                   |       |                  | 1,200      |              |       | 7,489         |       |   | 624.1 |   |   |
| **Net  income**                     | $          |                    | 11,621     |                  | $          |              | 730        |          | $          |   | 10,891 |   |   | 1,491.9 |   | % |

 

**Non****-GAAP Financial Measures**

 

Compensation cost for stock-based awards are measuredat fair value on the date of grant and recognized as compensation expense overthe requisite service period, net of estimated forfeitures.

 

We reported our compensation and benefits expense, incomebefore income taxes, income tax expense, net income, compensation ratio andbasic and diluted earnings per share on a non-GAAP basis for the three monthsended March 31, 2010 in our April 29, 2010 press release. Thenon-GAAP amounts exclude compensation expense related to the amortization ofIPO restricted stock awards granted in November 2006.

 

Our management has utilized such non-GAAP calculationsas an additional device to aid in understanding and analyzing our financialresults for the periods ended March 31, 2010 and 2009. Specifically, ourmanagement believes that these non-GAAP

 

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measures provide useful information by excluding certain items that maynot be indicative of our core operating results and business outlook. Ourmanagement believes that these non-GAAP measures will allow for a betterevaluation of the operating performance of our business and facilitatemeaningful comparison of our results in the current period to those in priorand future periods. Such periods did not and likely will not includesubstantial grants of restricted stock awards to employees such as theCompany-wide IPO restricted stock awards. Our reference to these non-GAAPmeasures should not be considered as a substitute for results that arepresented in a manner consistent with GAAP. These non-GAAP measures areprovided to enhance investors’ overall understanding of our current financialperformance.

 

A limitation of utilizing these non-GAAP measures isthat the determination of these amounts in accordance with GAAP reflects theunderlying financial results of our business. These effects should not be ignored in evaluating and analyzing ourfinancial results. Therefore, management believes that, with respect to theitems set forth in the table below, both our GAAP and respective non-GAAPmeasures should be considered together.

 

The following table provides details with respect to reconcilingcompensation and benefits expense, income before income taxes, income taxexpense, net income, compensation ratio and basic and diluted earnings pershare on a non-GAAP basis for the three months ended March 31, 2010 and2009.

 
|                                                       | ** ** | ** **                                                | ** ** | **Reconciliation** | ** **                | ** **   |
|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------|---------------------------|--------------|
|                                                       | ** ** | **GAAP**                                                  | ** ** | **Amount**         | ** **                | **Non-GAAP** |
| ** **                                                 | ** ** | **(dollars  in thousands, except per share information)** |
| **Quarter  Ended March 31, 2010**                     |       |                                                      |       |               |                      |         |   |   |   |   |
| Compensation and  benefits expense                         | $          |                                                      | 81,878     |               | $                         |         | (2,558 | ) | (a) | $ |   | 79,320 |   |
| Income before  income taxes                                | $          |                                                      | 20,310     |               | $                         |         | 2,558 |   | (a) | $ |   | 22,868 |   |
| Income tax  expense                                        | $          |                                                      | 8,689      |               | $                         |         | 1,094 |   | (b) | $ |   | 9,783 |   |
| Net income                                                 | $          |                                                      | 11,621     |               | $                         |         | 1,464 |   | (c) | $ |   | 13,085 |   |
| Compensation  ratio (d):                                   |       | 61.4                                                      | %          |               |                      |         |   |   | 59.5 | % |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
| Earnings per  share (e):                                   |       |                                                      |       |               |                      |         |   |   |   |   |
| Basic                                                      | $          |                                                      | 0.32       |               | $                         |         | 0.04 |   |   | $ |   | 0.36 |   |
| Diluted                                                    | $          |                                                      | 0.32       |               | $                         |         | 0.04 |   |   | $ |   | 0.36 |   |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
| Weighted average  number of common shares outstanding (e): |       |                                                      |       |               |                      |         |   |   |   |   |
| Basic                                                      |       | 32,240,838                                                |       |               | -     |         | (f) |   | 32,240,838 |   |
| Diluted                                                    |       | 32,240,838                                                |       |               | -     |         | (f) |   | 32,240,838 |   |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
| **Quarter  Ended March 31, 2009**                     |       |                                                      |       |               |                      |         |   |   |   |   |
| Compensation and  benefits expense                         | $          |                                                      | 45,667     |               | $                         |         | (2,302 | ) | (a) | $ |   | 43,365 |   |
| Income before  income taxes                                | $          |                                                      | 1,930      |               |                      | 2,302        |   | (a) | $ |   | 4,232 |   |
| Income tax  expense                                        | $          |                                                      | 1,200      |               | $                         |         | 1,431 |   | (b) | $ |   | 2,631 |   |
| Net income                                                 | $          |                                                      | 730        |               | $                         |         | 871 |   | (c) | $ |   | 1,601 |   |
| Compensation  ratio (d):                                   |       | 63.2                                                      | %          |               |                      |         |   |   | 60.0 | % |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
| Earnings per  share (e):                                   |       |                                                      |       |               |                      |         |   |   |   |   |
| Basic                                                      | $          |                                                      | 0.02       |               | $                         |         | 0.03 |   |   | $ |   | 0.05 |   |
| Diluted                                                    | $          |                                                      | 0.02       |               | $                         |         | 0.03 |   |   | $ |   | 0.05 |   |
|                                                       |       |                                                      |       |               |                      |         |   |   |   |   |
| Weighted average  number of common shares outstanding (e): |       |                                                      |       |               |                      |         |   |   |   |   |
| Basic                                                      |       | 31,354,507                                                |       |               | -     |         | (f) |   | 31,354,507 |   |
| Diluted                                                    |       | 31,354,507                                                |       |               | -     |         | (f) |   | 31,354,507 |   |

 

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(a)          The non-GAAP adjustment represents the pre-tax expensewith respect to the amortization of the IPO restricted stock awards granted toemployees on November 2006.

 

(b)         The non-GAAP adjustment with respect to income taxexpense represents the elimination of the tax benefit resulting from theamortization of the IPO restricted stock awards in the period.

 

(c)          The non-GAAP adjustment with respect to net income wasthe after-tax amortization of the IPO restricted stock awards in the period.

 

(d)         The first quarter 2010 and first quarter 2009compensation ratios were calculated by dividing compensation and benefitsexpense by total revenues of $133,310 and $72,276, respectively.

 

(e)          Basic and diluted common shares outstanding were equalfor each respective period under the two-class method.

 

(f)            Both the basic and diluted weighted average number ofcommon shares outstanding were not adjusted.

 

Our management utilizes these non-GAAP calculations inunderstanding and analyzing our financial results.  Our managementbelieves that the non-GAAP measures provide useful information by excludingcertain items that may not be indicative of our core operating results andbusiness outlook. Our management believes that these GAAP measures will allowfor a better evaluation of the operating performance of our business andfacilitate meaningful comparison of our results in the current period to thosein prior periods and future periods. Our reference to these non-GAAP measuresshould not be considered as a substitute for results that are presented in amanner consistent with GAAP. These non-GAAP measures are provided to enhanceinvestors’ overall understanding of our current financial performance.

 

A limitation of utilizing these non-GAAP measures isthat the GAAP accounting effects of these events do in fact reflect the underlyingfinancial results of our business and these effects should not be ignored inevaluating and analyzing our financial results. Therefore, management believesthat our GAAP measures of compensation and benefits expense, income beforeincome taxes, income tax expense, net income, and basic and diluted earningsper share and the same respective non-GAAP measures of our financialperformance should be considered together.

 

We expect to grant restricted stock awards and othershare-based compensation in the future. We do not expect to make any suchsubstantial grants to employees outside of our regular compensation and hiringprocess, as we did when we granted IPO restricted stock awards.

 

**Revenues**

 

***Investment Banking***

 

Investment banking revenue was $70.0 million for thethree months ended March 31, 2010 compared with $26.9 million for thesame period in 2009, an increase of $43.1 million, or 160.5%. Capitalmarkets revenue increased $36.1 million, or 206.3%, to a quarterly record of$53.6 million for the three months ended March 31, 2010 compared with$17.5 million for the same period in 2009. The increase reflects thecompletion of a significantly higher number of equity capital markettransactions in 2010 compared with the same period in 2009.  The majority of such transactions related toraising common equity capital for U.S. banking companies continuing the trendthat began in the second quarter of 2009 following the completion by federalbank regulators of the Supervisory Capital Assessment Program which providedthe market with an approach to estimating loan losses in valuing U.S. bankstocks.  M&A and advisory revenue was$16.4 million for the three months ended March 31, 2010 compared with$9.4 million for the same period in 2009, an increase of $7.0 million.  This increase was primarily due to an aboveaverage advisory fee earned from a transaction that closed in 2010.

 

***Commissions***

 

Commissions revenue was $35.4 million for thethree months ended March 31, 2010 compared with $36.0 million for thesame period in 2009, a decrease of $0.6 million, or 1.7%. European equitycommissions were $10.4 million for the three months ended March 31, 2010compared with $8.6 million for the same period in 2009, an increase of $1.8million, or 20.9%, reflecting higher trading volume and the recovery of themarket valuation of most European financial services stocks on which ourEuropean commissions are based. U.S. equity commissions were $25.0 million forthe three months ended March 31, 2010 compared with $27.5 million for thesame 2009 period, a decrease of $2.5 million, or 9.1%, reflecting lower tradingvolume.

 

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***Principal Transactions, Net***

 

Principal transactions, net resulted in revenue of$19.0 million for the three months ended March 31, 2010 compared with $4.1million for the same period in 2009.  Ourfixed income revenue was $12.9 million for the three months ended March 31,2010 compared to $10.2 million for the same period in 2009. Our equity marketmaking activity resulted in a loss of $0.9 million for three months ended March 31,2010 compared to a loss of $1.5 million for the same period in 2009. Tradingfor our own account, including firm investments, resulted in a net gain of $7.4million for 2010 compared to a net loss of $1.0 million for the same period in2009, reflecting an improved trading environment. The realized gain/loss andchange in the fair value of our trust preferred backed collateralized debtobligations and related securities owned resulted in a loss of $0.4 million for2010 compared to a loss of $3.5 million for the same period in 2009.

 

***Interest and Dividend Income***

 

Interest and dividend income increased $1.1 million,or 65.9%, to $2.9 million for the three months ended March 31, 2010compared with $1.7 million for the same period in 2009.  The increase was primarily due to higheraverage holdings of interest bearing assets in 2010 relative to 2009.

 

***Other***

 

Other revenues increased $2.5 million, or 77.1%, to$5.7 million for the three months ended March 31, 2010 compared with $3.2million for the same period in 2009. The increase was primarily due to higherloan portfolio sales fees compared with the same period in 2009.

 

**Expenses**

 

***Compensation and Benefits***

 

Compensation and benefits expense was $81.9 million,an increase of $36.2 million, or 79.3% for the three months ended March 31,2010 compared with $45.7 million for the same period in 2009, reflectinghigher revenues.  Compensation andbenefits as a percentage of total revenue, after adjusting for expensesassociated with the IPO restricted stock awards, was 59.5% for the firstquarter of 2010 compared to 60.0% for the same period in 2009. See“-Non-GAAP Financial Measures” for a reconciliation of our non-GAAPmeasures to their corresponding GAAP amounts.

 

***Brokerage and Clearance***

 

Brokerage and clearance expense was $5.1 million forthe three months ended March 31, 2010 compared with $3.9 million forthe same period in 2009, an increase of $1.2 million, or 31.0%.  The increase was primarily a result of higherclearance charges on European equities.

 

***BusinessDevelopment***

 

Business development expense increased $0.4 million,or 14.1%, to $3.5 million for the three months ended March 31, 2010compared with $3.0 million for the same period in 2009.  The increase was primarily due to highertravel and entertainment expenses in 2010 relative to 2009.

 

***Other***

 

Other expenses were $9.1 million for the three monthsended March 31, 2010 compared with $5.8 million for the same period in2009, an increase of $3.3 million, or 56.7%. The increase was primarily due to higher legal costs in 2010 relative to2009.

 

***Income Tax Expense***

 

Income tax expense was $8.7 million for the threemonths ended March 31, 2010, which resulted in an effective tax rate of42.8%, compared to $1.2 million for the same period in 2009, which resulted inan effective tax rate of 62.2%.  Thechange in the effective tax rate was primarily due to the impact of permanentdifferences relative to increased pre-tax income.

 

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**CriticalAccounting Policies and Estimates**

 

The preparation of our consolidated financialstatements requires us to make estimates and assumptions that affect thereported amounts of assets and liabilities and of revenues and expenses duringthe reporting periods. We base our estimates and assumptions on historicalexperience and on various other factors that we believe are reasonable underthe circumstances. The use of different estimates and assumptions could producematerially different results. For example, if factors such as those describedin Item 1A under “Risk Factors” cause actual events to differ from theassumptions we used in applying the accounting policies, our results ofoperations, financial condition and liquidity could be materially adverselyaffected.

 

Our significantaccounting policies are summarized in Note 2 of the Notes to ConsolidatedFinancial Statements. On an ongoing basis, we evaluate our estimates and assumptions,particularly as they relate to accounting policies that we believe are mostimportant to the presentation of our financial condition and results ofoperations. We regard an accounting estimate or assumption to be most importantto the presentation of our financial condition and results of operations wherethe nature of the estimate or assumption is material due to the level ofsubjectivity and judgment necessary to account for highly uncertain matters orthe susceptibility of such matters to change, as well as the impact of theestimate or assumption on our financial condition or operating performance ismaterial.

 

Based on these criteria, we believe the following tobe our critical accounting policies:

 

***Fair Value of Financial Instruments***

 

We account for financial instruments that are beingmeasured and reported on a fair value basis in accordance with FASB AccountingStandards CodificationTM (“ASC”) 820, *Fair Value Measurementsand Disclosures.*ASC 820 defines fair value, establishes a frameworkfor measuring fair value and requires enhanced disclosures about fair valuemeasurements. ASC 820 defines fair value as “the price that would be receivedto sell an asset and paid to transfer a liability in an ordinary transactionbetween current market participants at the measurement date.”  See Note 3 of the Notes to ConsolidatedFinancial Statements for a more detailed discussion of fair value of financialinstruments.

 

ASC 825, *Financial Instruments,*providesentities the option to measure certain financial assets and financialliabilities at fair value with changes in fair value recognized in earningseach period.  ASC 825 permits the fairvalue option election, on an instrument-by-instrument basis, either at initialrecognition of an asset or liability or upon an event that gives rise to a newbasis of accounting for that instrument. Such election must be applied to the entire instrument and not only aportion of the instrument. We applied the fair value option for certaineligible instruments, including all private equity securities and limitedpartnership interests, as these financial instruments had been accounted for atfair value prior to the fair value option election in accordance with the *AICPA Audit and Accounting Guide — Brokers And Dealers In Securities*(ASC 940).

 

Financial instruments are valued at quoted marketprices, if available. For financial instruments that do not have readilydeterminable fair values through quoted market prices, the determination offair value is based upon consideration of available information, includingtypes of financial instruments, current financial information, restrictions ondispositions, fair values of underlying financial instruments and quotationsfor similar instruments.

 

The valuation process for financial instruments mayinclude the use of valuation models and other techniques. Adjustments tovaluations derived from valuations models may be made when, in management’sjudgment, either the size of the position in the financial instrument in anonactive market or other features of the financial instrument such as itscomplexity, or the market in which the financial instrument is traded (such ascounterparty, credit, concentration or liquidity) require that an adjustment bemade to the value derived from the models. An adjustment may be made if afinancial instrument is subject to sales restrictions that would result in aprice less than the quoted market price. Adjustments from the price derivedfrom a valuation model reflects management’s judgment that other participantsin the market for the financial instrument being measured at fair value wouldalso consider in valuing that same financial instrument and are adjusted forassumptions about risk uncertainties and market conditions. Results fromvaluation models and valuation techniques in one period may not be indicativeof future period fair value measurements.

 

*FairValue Hierarchy*

 

In determining fair value, we utilize various methods including the market and income approaches. Based on these approaches, we utilize assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or

 

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generally unobservable firm inputs. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, we are required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.   Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories:

 
| Level 1 | Quoted market prices in active markets for identical  assets or liabilities.                 |
|---------|----------------------------------------------------------------------------------------------|
| Level 2 | Observable market based inputs or unobservable  inputs that are corroborated by market data. |
| Level 3 | Unobservable inputs that are not corroborated by  market data.                               |

 

Level 1 primarily consists of listed financialinstruments whose value is based on quoted market prices, such as listedequities, options and warrants, and convertible preferred stock. This categorymay also include U.S. Government and agency securities for which we typicallyreceive independent external valuation information.

 

Level 2 includes those financial instruments that arevalued using multiple valuation techniques, primarily a market approach.  The valuation methodologies utilized arecalibrated to observable market inputs. We consider recently executedtransactions, market price quotations and various assumptions, such as creditspreads, the terms and liquidity of the instrument, the financial condition,operating results and credit ratings of the issuer or underlying company, thequoted market price of publicly traded securities with similar duration andyield, time value, yield curve, as well as other measurements. In order to beclassified as Level 2, substantially all of these assumptions would need to beobservable in the marketplace or can be derived from observable data orsupported by observable levels at which transactions are executed in themarketplace. Financial instruments in this category include certain corporatedebt, residential mortgage-backed securities, CDOs primarily collateralized bybanking and insurance company trust preferred and capital securities, certainpreferred stock, convertible debt and residentialmortgage-backed securities.

 

Fair value of corporate debt, preferred stock,convertible debt and residential mortgage-backed securities classified as Level2 was determined by using quoted market prices, broker or dealer quotes, oralternate pricing sources with reasonable levels of price transparency.  Fair value of CDOs primarily collateralizedby banking and insurance company trust preferred and capital securities wasdetermined primarily by considering recently executed transactions of similarsecurities and certain assumptions, including the financial condition,operating results and credit ratings of the issuer or underlying companies.

 

Level 3 is comprised of financial instruments whosefair value is estimated based on multiple valuation techniques, primarilymarket and income approaches. The valuation methodologies utilized may includesignificant inputs that are unobservable from objective sources. We considervarious market inputs and assumptions, such as recently executed transactions,market price quotations, discount margins, market spreads applied, the termsand liquidity of the instrument, the financial condition, operating results andcredit ratings of the issuer or underlying company, the quoted market price ofpublicly traded securities with similar duration and yield, time value, yieldcurve, default rates, as well as other measurements.  Included in this category are certaincorporate and other debt, including banking and insurance company trustpreferred and capital securities, private equity securities and otherinvestments including limited and general partnership interests.

 

Fair value of banking and insurance company trustpreferred and capital securities wasdetermined by utilizing a market spread method for each of theindividual trust preferred and capital securities utilizing credit spreads forsecondary market trades for trust preferred and capital securities for issueswhich were substantially similar to such positions based on certainassumptions. The key market inputs in this method are the discount margins,market spreads applied, the yield expectations for similar instruments and thefinancial condition, operating results and credit ratings of the issuer orunderlying company.

 

Fair value of private equity securities was determinedby assessing market-based information, such as performance multiples,comparable company transactions and changes in market outlook. Fair value oflimited and general partnership interests was determined by using net assetvalues or capital statements provided by the general partner, updated forchanges in market conditions up to the reporting date.  Private equity securities and limited andgeneral partnership interests generally trade infrequently.

 

The variables affecting fair value estimates of thesefinancial instruments can change rapidly and unexpectedly, which could have asignificant impact on the fair value estimates of these financial instruments.Results from valuation techniques in one period may not be indicative of futureperiod fair value measurements.

 

Our Level 3 assets were $89.9 million as of March 31,2010, which represented approximately 15% of total assets and approximately 38%of total assets measured at fair value.

 

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The availability of observable inputs can vary fromproduct to product and is affected by a wide variety of factors, including, forexample, the type of product, whether the product is new and not yetestablished in the marketplace, and other characteristics particular to thetransaction. To the extent that valuation is based on models or inputs that areless observable or unobservable in the market, the determination of fair valuerequires more judgment. Accordingly, the degree of judgment exercised bymanagement in determining fair value is greatest for instruments categorized inlevel 3. In certain cases, the inputs used to measure fair value may fall intodifferent levels of the fair value hierarchy. In such cases, for disclosurepurposes, the level in the fair value hierarchy within which the fair valuemeasurement in its entirety falls is determined based on the lowest level inputthat is significant to the fair value measurement in its entirety.

 

Fair value is a market-based measure considered fromthe perspective of a market participant who holds the asset or owes theliability rather than an entity-specific measure. When market assumptions arenot readily available, management’s assumptions are set to reflect those thatmarket participants would use in pricing the asset or liability at themeasurement date. We use prices and inputs that are current as of themeasurement date, including during periods of market dislocation. In periods ofmarket dislocation, the observability of prices and inputs may be reduced formany instruments. This condition could cause an instrument to be reclassifiedfrom level 1 to level 2, or from level 2 to level 3.

 

*FairValue of Financial Instruments Control Process*

 

We employ a variety of control processes to validatethe fair value of our financial instruments, including those derived fromutilizing valuation techniques. Individuals outside of the trading departmentsobtain independent prices, as appropriate. Where a valuation technique is usedto determine fair value, recently executed comparable transactions and otherobservable market data are considered for purposes of validating assumptionsunderlying the valuation technique. These control processes are designed toassure that the values used for financial reporting are based on observableinputs wherever possible. In the event that observable inputs are notavailable, the control processes are designed to assure that the valuationapproach utilized is appropriate and consistently applied and that theassumptions are reasonable. These control processes include reviews bypersonnel with relevant expertise who are independent from the trading desks,including involvement by senior management.

 

***Income Taxes***

 

Deferred tax assets andliabilities are recognized for the future tax attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferred taxassets and liabilities are measured using enacted tax rates.  The effect on deferred tax assets andliabilities of a change in tax rates is recognized in earnings in the periodthat includes the enactment date.   Inthe event it is more likely than not that a deferred tax asset will not berealized, a valuation allowance will be recorded.

 

We apply ASC 740, *Income Taxes,*whichprescribes a single, comprehensive model for how a company should recognize,measure, present and disclose in its financial statements uncertain taxpositions that the company has taken or expects to take on its taxreturns.  Income tax expense is based onpre-tax accounting income, including adjustments made for the recognition orderecognition related to uncertain tax positions.

 

**Contractual Obligations**

 

As of March 31, 2010, our contractual obligationswith respect to operating leases and partnership commitments have notsignificantly changed since December 31, 2009.

 

**Off-BalanceSheet Arrangements**

 

In the normal course of our principal tradingactivities, we may enter into transactions in financial instruments withoff-balance-sheet risk. These financial instruments, such as options, warrants,futures contracts and mortgage-backed to-be-announced securities, containoff-balance-sheet risk inasmuch as ultimate settlement of these transactionsmay have market and/or credit risk in excess of amounts which are recognized inthe consolidated financial statements. Transactions in listed options andwarrants are conducted through regulated exchanges, which clear and guaranteeperformance of counterparties. As described in Item 3 — “Qualitative andQuantitative Disclosures About Market Risk — Credit Risk,” throughindemnification provisions in our clearing agreements with our clearingbrokers, customer activities may expose us to off-balance sheet credit risk,which we seek to mitigate through customer screening and collateralrequirements.

 

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We are a member of various exchanges that trade andclear securities, options, warrants and or futures contracts. As a member ofthese exchanges, we may be required to pay a proportionate share of thefinancial obligations of another member who may default on its obligations tothe exchange. To mitigate these performance risks, the exchanges often requiremembers to post collateral as well as meet minimum financial standards. Whilethe rules governing different exchange memberships vary, our guaranteeobligations generally would arise only if the exchange had previously exhaustedits resources. In addition, any such guarantee obligation would be apportionedamong the other non-defaulting members of the exchange. Any potentialcontingent liability under these membership agreements cannot be estimated. Wehave not recorded any contingent liability in our consolidated financialstatements for these agreements and currently believe that any potentialrequirement to make payments under these agreements is remote**.**

 

**Recently Issued AccountingStandards, Not Yet Adopted**

 

In January 2010, FASB issued ASU No. 2010-06*, Fair Value Measurements and Disclosures (Topic 820): ImprovingDisclosures about Fair Value Measurements.*  ASU No. 2010-06 requires additional fairvalue measurement disclosure requirements and clarifies certain existingdisclosure requirements. The additional disclosures include significanttransfers in and out of Level 1 and Level 2 fair value measurements, andreasons for the transfers, and activity in Level 3 fair valuemeasurements.  ASU No. 2010-06 iseffective for interim and annual periods beginning after December 15,2009, except for the disclosures on the activity in Level 3 fair valuemeasurements, which is effective for interim and annual periods beginning afterDecember 15, 2010. In January 2010, we adopted ASU No. 2010-06,except for the disclosure requirements related to the activity in Level 3 fairvalue measurements.

 

**Liquidity and Capital Resources**

 

We are the parent of Keefe, Bruyette & Woods, Inc.(“Keefe”), Keefe, Bruyette & Woods Limited (“KBWL”), Keefe, Bruyette &Woods Asia Limited (“KBWAL”), KBW Asset Management, Inc. (“KBWAM”) and KBWVentures, Inc.  Dividends and othertransfers from our subsidiaries are our primary source of funds to satisfy ourcapital and liquidity requirements. Applicable laws and regulations, primarilythe net capital rules discussed below, restrict dividends and transfersfrom Keefe, KBWL and KBWAL to us. Our rights to participate in the assets ofany subsidiary are also subject to prior claims of the subsidiary’s creditors,including customers and trade creditors of Keefe, KBWL, KBWAL and KBWAM.

 

We monitor and evaluate the composition and size ofour assets and operating liabilities. As a result of our market making,customer and principal activities, the overall size of total assets andoperating liabilities fluctuate from period to period. Our assets generallyconsist of cash and cash equivalents, financial instruments, resale agreementbalances and receivables.

 

Our operating activities in the period generate anduse cash resulting from net income or loss and fluctuations in our currentassets and liabilities. The most significant fluctuations in current assets andliabilities have resulted from changes in the level of customer activity,changes in the types of and value of the financial instruments owned on aprincipal basis and shifts in our investment positions in response to changesin our trading strategies or prevailing market conditions. We have not reliedsignificantly on leverage. Our moderate use of leverage does not expose us topotential requirements to sell assets as a result of margin calls due todecreases in the fair value of financial instruments.

 

We have historically satisfied our capital andliquidity requirements through capital from our stockholders and internallygenerated cash from operations. As of March 31, 2010, we had liquid assetsof $260.0 million, consisting of cash and cash equivalents and receivables fromclearing brokers.  From time to time, wemay obtain a short term subordinated loan from our U.S. clearing broker tosupport underwriting activity over a very short time. We may also finance fixedincome positions with securities sold under repurchase agreements as well asutilizing margin borrowing from the clearing brokers.

 

Although we believe such sources remain available, wedo not currently plan to obtain such short-term subordinated financing from anyoutside source. We do not currently have any long term debt obligations andtherefore, are not exposed to the breach of any debt covenants.

 

We have an effective “universal” shelf registrationstatement on form S-3 on file with the SEC. This shelf registration statement enables us to sell, from time to time,the securities covered by the registration statement in one or more publicofferings. The securities covered by the registration statement include commonstock, preferred stock, depositary shares, senior debt securities, subordinateddebt securities, warrants, stock purchase contracts, and stock purchase units.We may offer any of these securities independently or together in anycombination with other securities. In addition, selling shareholders may usethe shelf registration statement to offer, from time to time, shares of ourcommon stock.  Our status as a“well-known seasoned issuer,” as such term is

 

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defined in the federal securities laws, enables us, among other things,to enter the public markets and consummate sales off the shelf registrationstatement in rapid fashion and with little or no notice.

 

The timing of cash bonus payments to our employees maysignificantly affect our cash position and liquidity from period to period.While our employees are generally paid salaries semi-monthly during the year,cash bonus payments, which make up a larger portion of total compensation, aregenerally paid once a year. Cash bonus payments for a given year are generallypaid in February of the following year. We continually monitor ourliquidity position and believe our available liquidity will be sufficient tofund our operations over the next twelve months.

 

As a registered broker-dealer and member firm of theNYSE, Keefe is subject to the uniform net capital rule of the SEC. We usethe basic method permitted by the uniform net capital rule, which generallyrequires that the ratio of aggregate indebtedness to net capital cannot exceed15 to 1. The NYSE may prohibit a member firm from expanding its business orpaying dividends if resulting net capital would be below the regulatory limit.We do not expect that these limits will materially impact our ability to meetour current and future obligations. We have not been the subject to anyregulatory restrictions as a result of the decreases in the fair value of ourfinancial instruments.

 

At March 31, 2010, Keefe’s net capital under theSEC’s Uniform Net Capital Rule was $107.3 million, or $103.9 million inexcess of the minimum required net capital.

 

KBWL is subject to the capital requirements of theU.K. Financial Services Authority. KBWL’s total capital resources of $34.2million exceeded the capital resources requirement by approximately $24.4million at March 31, 2010.

 

***CashFlows***

 

*Threemonths ended March 31, 2010.** *** Cash decreased$26.0 million during the three months ended March 31, 2010, primarily dueto cash used from operating and financing activities of $13.9 million and $9.4million, respectively.

 

Net income, after adjusting for non-cash expense andrevenue items of $18.6 million, provided cash of $30.2 million.  The non-cash items consisted of expenses of$14.3 million resulting from the amortization of stock-based compensation, $3.1million related to deferred income tax expense and $1.3 million related todepreciation and amortization. Cash of $4.1 million was provided as a result ofa decrease in operating assets, primarily attributable to a decrease relatedreceivables from clearing brokers of $78.6 million offset by increases infinancial instruments owned, at fair value of $60.7 million and accountsreceivable of $11.1 million.  Cash of$48.3 million was used as a result of an increase in operating liabilities,primarily attributable to a decrease in accounts payable, accrued expenses, andother liabilities of $71.2 million, partially offset by a $19.4 millionincrease in financial instruments sold, not yet purchased, at fair value.

 

We used $1.1 million in our investing activities forthe purchase of fixed assets. Cash used in financing activities was$9.4 million, primarily as a result of the cancellation of restrictedstock in satisfaction of withholding tax requirements.

 

*Threemonths ended March 31, 2009.* Cash decreased $48.9 million during the three monthsended March 31, 2009, primarily due to negative cash flows from operatingactivities.

 

Our operating activities used $42.6 million of cash.Cash used as a result of decreasing operating liabilities by $65.4 million waspartially offset by net income, adjusted for non-cash revenue and expense itemsof $13.6 million, which contributed $14.3 million and cash provided fromoperating assets of $8.4 million. The non-cash items consisted ofamortization of stock-based compensation related to restricted stock of$12.0 million, depreciation and amortization expense of $1.2 million anddeferred income tax expense of $0.4 million. Cash provided by operatingassets was primarily attributable to decreases in financial instruments owned,at fair value of $11.4 million and receivables from clearing brokers of$4.3 million, partially offset by an increase in securities purchasedunder resale agreements of $8.1 million. Cash used in operating liabilities consisted primarily of a decrease ofaccounts payable, accrued expenses and other liabilities of $92.4 million,partially offset by increases in financial instruments sold, not yet purchased,at fair value of $18.2 million and securities sold under repurchaseagreements of $8.6 million.

 

We used $1.0 million in our investing activities, inthe purchase of fixed assets. Cash used in financing activities was$4.2 million primarily as a result of the cancellation of restricted stockin satisfaction of withholding tax requirements.

 

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**Item 3.    Quantitative and Qualitative Disclosures About MarketRisk.**

 

***Market Risk***

 

Market risk represents the risk of loss that mayresult from the change in value of a financial instrument due to fluctuationsin its market price. Market risk may be exacerbated in times of tradingilliquidity when market participants refrain from transacting in normalquantities and/or at normal bid-offer spreads. Our exposure to market risk isdirectly related to our role as a financial intermediary in customer tradingand to our market making and investment activities. Market risk is inherent infinancial instruments.

 

We trade in equity and debt securities as an activeparticipant in both listed and over the counter markets. We typically maintainsecurities in inventory to facilitate our market making activities and customerorder flow. We may use a variety of risk management techniques and hedgingstrategies in the ordinary course of our trading business to manage ourexposures.

 

In connection with our sales and trading business,management also reviews reports appropriate to the risk profile of specifictrading activities. Management monitors risks in its trading activities by establishingand periodically reviewing limits for each trading desk and reviewing dailytrading results, inventory aging, securities concentrations and ratings.Typically, market conditions are evaluated and transaction details andsecurities positions are reviewed. These activities seek to ensure that tradingstrategies are within acceptable risk tolerance parameters. Activities includeprice verification procedures, position reconciliations and reviews oftransaction bookings. We believe these procedures, which stress timelycommunications between traders, trading management and senior management, areimportant elements of the risk management process.

 

The following table sets forth our monthly high, lowand average long/short financial instruments owned for the three months ended March 31,2010:

 
|                                   | ** ** | **High**                    | ** ** | **Low** | ** ** | **Average** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|---------|------------|-------------|------------|
| ** **                             | ** ** | **(dollars  in thousands)** |       |
| **Long  Value:**                       |       |                        |       |    |       |        |       |
| Equities                               |       | $                           | 85,166     |    | $          | 56,720      |       | $ | 77,086 |   |
| Corporate and  other debt              |       | $                           | 75,754     |    | $          | 47,656      |       | $ | 66,239 |   |
| Mortgage-backed  securities            |       | $                           | 33,656     |    | $          | -           |       | $ | 11,557 |   |
| Other  investments                     |       | $                           | 45,092     |    | $          | 41,917      |       | $ | 43,369 |   |
| **Short  Value:**                      |       |                        |       |    |       |        |       |
| Equities                               |       | $                           | 49,509     |    | $          | 31,289      |       | $ | 38,690 |   |
| Corporate debt                         |       | $                           | 7,186      |    | $          | 2,408       |       | $ | 4,532 |   |
| U.S. Government  and agency securities |       | $                           | 9,075      |    | $          | 774         |       | $ | 3,778 |   |

 

***Interest Rate Risk***

 

Interest rate risk represents the potential loss fromadverse changes in market interest rates. As we may hold debt securities fromtime to time, we are exposed to interest rate risk arising from changes in thelevel 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 inU.S. Government and agency securities.

 

***Credit Risk***

 

We engage in various securities underwriting, tradingand brokerage activities servicing a diverse group of domestic and foreigncorporations and institutional investor clients. Our exposure to credit riskassociated with the nonperformance of these clients in fulfilling theircontractual obligations pursuant to securities transactions can be directlyimpacted by volatile trading markets which may impair the client’s ability tosatisfy its obligations to us. Our principal activities are also subject to therisk of counterparty nonperformance. Pursuant to our Clearing Agreements withPershing LLC and Pershing Securities Limited, we are required to reimburse ourclearing broker without limit for any losses incurred due to a counterparty’sfailure to satisfy its contractual obligations. In these situations, we may berequired to purchase or sell financial instruments at unfavorable market pricesto satisfy obligations to other customers or counterparties. We seek tomitigate the risks associated with sales and trading services through activecustomer screening and selection procedures and through requirements thatclients maintain collateral in appropriate amounts where required or deemednecessary.

 

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***Inflation Risk***

 

Because a significant portion of our assets arerelatively liquid in nature, they are not significantly affected by inflation.However, the rate of inflation affects such expenses as employee compensationand communications charges, which may not be readily recoverable in the pricesof services we offer. To the extent inflation results in rising interest ratesand has other adverse effects on the securities markets, it may adverselyaffect our combined financial condition and results of operations in certainbusinesses.

 

***Operational Risk***

 

Operational risk is the risk of loss resulting frominadequate or failed internal processes, people and systems or from externalevents. We are focused on maintaining our overall operational risk managementframework and minimizing or mitigating these risks through continualassessment, reporting and monitoring of potential operational risks.

 

**Item 4.         Controlsand Procedures.**

 

Our management, with theparticipation of the Chief Executive Officer and the Chief Financial Officer(our principal executive officer and principal financial officer,respectively), evaluated the effectiveness of our disclosure controls andprocedures pursuant to Rule 13a-15 under the Exchange Act as of the end ofthe period covered by this report.

 

Based on that evaluation, our Chief Executive Officerand Chief Financial Officer have concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Exchange Act) are effective to ensure that information required to bedisclosed by us in the reports filed or submitted by us under the Exchange Act,is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and include controls andprocedures designed to ensure that information required to be disclosed by usin such reports is accumulated and communicated to our management, includingthe Chief Executive Officer and the Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure.

 

There was no change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the ExchangeAct) that occurred during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II–OTHER INFORMATION**

 

**Item 1.    Legal Proceedings*.***

 

Our businesses, as well as the financial servicesindustry generally, are subject to extensive regulation. From time to time, inthe ordinary course of our business, we are involved in judicial, regulatoryand arbitration proceedings and inquiries concerning matters arising inconnection with the conduct of our businesses.

 

*SentinelManagement Group Litigation*

 

A lawsuit was filed on January 12, 2009 byFrederick J. Grede, as Liquidation Trustee and Representative of the Estate ofSentinel Management Group, Inc., in the United States District Court forthe Northern District of Illinois against Keefe and against Delores E.Rodriguez; Barry C. Mohr, Jr.; and Jacques De Saint Phalle (all formeremployees of Keefe) and Cohen & Company Securities, LLC, as describedin the “Legal Proceedings” section of our Annual Report on Form 10-K forthe year ended December 31, 2009.

 

On May 21, 2009 the Trustee filed an additionalcomplaint in the same court and against the same parties (the “SecondComplaint”).  The Trustee claimed to beacting in the Second Complaint in his capacity as liquidation trustee and as anassignee of claims of Sentinel’s customers. The Second Complaint makes substantially the same allegations as thecomplaint described above.  Keefebelieves the claims in the Second Complaint are also without merit and willdefend these claims vigorously.  On July 28,2009, in *Grede v. Bank of New York Mellon* et alfiled in the same court, in which the Trustee alleged similar customer claimsas an assignee, the court dismissed the Trustee’s claims due to lack ofstanding.  The Trustee has appealed thecourt’s dismissal of *Grede v. Bank of New YorkMellon* and, on August 19, 2009, the court stayed the SecondComplaint while the Trustee’s appeal in *Grede v. Bank of New YorkMellon* is pending.  On March 18, 2010, the Seventh Circuitreversed the district court, holding that the Trustee had standing to pursuethe assigned customer claims against Bank of New York Mellon.  Currently, the Second Complaint remainsstayed, pending the possibility of further appellate review in Grede v. Bank ofNew York Mellon, including en banc review by the Seventh Circuit and/or review bythe Supreme Court.  

 

*MidFirstBank Litigation*

 

OnDecember 6, 2007, MidFirst Bank (“MidFirst”) filed a lawsuit against Keefein the Federal District Court for the Western District of Oklahoma, in anaction captioned *MidFirst Bank v. Keefe, Bruyette &Woods, Inc.*, Case No. 07-CV-1384-R (W.D. Oklahoma.).  The complaint arises out of MidFirst’sinvestment in subordinated trust certificates, which Keefe solicited MidFirstto acquire in early 2007.  MidFirstacquired the securities for approximately $5.0 million.  During the fall of 2007, in connection withthe failure of the global markets, MidFirst’s investment declined invalue.  MidFirst sued Keefe, claimingthat Keefe misrepresented the terms of the securities.  MidFirst initially alleged that Keefeviolated Section 10(b) of the Exchange Act, the Oklahoma UniformSecurities Act, committed common law fraud and negligentmisrepresentation.   Keefe moved todismiss and the Court granted the motion to dismiss the Section 10(b) claimwhich was not repleaded.  Based on itsstate law claims, MidFirst is seeking a rescission of approximately $5.1million in compensatory damages and an unspecified sum for punitive damages andattorney’s fees or in the alternative damages of approximately $2.4 million.

 

Keefeanswered the complaint and brought a third-party complaint against WachoviaCapital Markets LLC (“Wachovia”), which solicited Keefe to sell thesesecurities and which knew Keefe was purchasing them for resale to acustomer.  Keefe’s claims againstWachovia are for contribution and indemnity, common law fraud and negligentmisrepresentation.  Wachovia has answeredthe third-party complaint, denying all material allegations.

 

Theparties are in the discovery process of this litigation and the case iscurrently scheduled for trial commencing in August 2010. Keefe has beenand is continuingto defendagainst the MidFirst suit and prosecuting Keefe’s claims against Wachoviavigorously.

 

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**Item 1A.****   ****Risk Factors.**

 

There have not been any material changes from the riskfactors previously disclosed in Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2009.

 

**Item 2.****      ****Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

There were no unregisteredsales of equity securities during the quarter ended March 31, 2010.

 

The table below sets forth the information withrespect to purchases made by or on behalf of KBW, Inc. or any “affiliatedpurchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act),of our common stock during the quarter ended March 31, 2010:

 
| **Period**                                            | ** ** | **Total Number of Shares  Purchased (1)(2)** | ** ** | **Average Price  Paid Per Share** | ** ** | **Total Number of Shares  Purchased as Part of  Publicly Announced Plans  or Programs** | ** ** | **Approximate Dollar  Value of Shares that May  Yet Be Purchased Under  the Plans or Programs** |
|-------------------------------------------------------|------------|------------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| January 1,  2010 to January 31, 2010        |       | –                                                           |       | –                                           |       | –                                                                                                                               |       | –                                                                                                                                                 |
| February 1,  2010 to February 28, 2010 |       | 433,879                                                          |       | $26.70                                           |       | –                                                                                                                               |       | –                                                                                                                                                 |
| March 1,  2010 to March 31, 2010            |       | –                                                           |       | –                                           |       | –                                                                                                                               |       | –                                                                                                                                                 |
|                                                  |       | 433,879                                                          |       | $26.70                                           |       | –                                                                                                                               |       | –                                                                                                                                                 |

 

(1)                    All shares purchased were other than as part of apublicly announced plan or program. The shares repurchased are equal to thenumber of shares that were withheld from certain employees to fund applicabletaxes owed by them as a result of the vesting of restricted stock awards.

 

(2)                    All shares were immediately retired upon purchase byus.

 

**Item3.        Defaults Upon SeniorSecurities.**

 

None.

 

**Item4.       Other Information.**

 

None.

 

**Item5.       Exhibits**.

 

See Exhibit Index.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

Date: May 6, 2010

 
|   | KBW, INC. |
|--------|-----------|
|   |      |
|   |      |
|   | By:       |   /s/ JOHN G. DUFFY |   |
|   |      | Name: | John G. Duffy |
|   |      | Title: | Chairman and Chief Executive Officer |
|   |      |
|   |      |
|   |      |
|   | By:       |   /s/ ROBERT GIAMBRONE |   |
|   |      | Name: | Robert Giambrone |
|   |      | Title: | Chief Financial Officer |
|        |           |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit** |       |                                                                                                                                                                                                                  |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                       |
| 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.                                                        |

 

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