OPERATOR: Good morning. My name is Michelle
and I will be your conference operator today. At this
time I would like to welcome everyone to the FBR Capital
Markets Third Quarter 2008 Earnings conference call. All
lines have been placed on mute to prevent any background
noise.
After the speakers' remarks, there will be a
question-and-answer session. If you would like to ask a
question during this time, simply press star and then the
number one on your telephone keypad.
If you have already done so, please press the
pound sign now, then press star one again to ensure your
question is registered.
If you would like to withdraw your question,
press the pound key. Thank you.
Mr. Bradley Wright, Chief Financial Officer,
sir, you may begin your conference.
BRAD WRIGHT: Thank you and good morning.
This is Brad Wright, Chief Financial Officer of FBR
Capital Markets. Before we begin this morning's call, I
would like to remind everyone that statements concerning
future performance, developments, events, market
forecasts, revenues, expenses, earnings, run rates, and
any other guidance on present or future periods
constitute forward-looking statements. These forward-
looking statements are subject to a number of factors,
risks, and uncertainties that might cause actual results
to differ materially from stated expectations or current
circumstances. These factors include, but are not
limited to, the effect of demand for public offerings,
activity in secondary securities markets, interest rates,
the risks associated with merchant banking investments,
the realization of gains and losses on principal
investments, available technologies, competition for
business and personnel, and general economic, political,
and market conditions. Additional information concerning
these factors that could cause results to differ
materially is contained in FBR Capital Markets' annual
report on Form 10-K and in quarterly reports on Form
10-Q.
I would now like to turn the call over to Eric
Billings, Chairman and Chief Executive Officer of FBR
Capital Markets. Also joining us this morning is Rick
Hendrix, President and Chief Operating Officer of FBR
Capital Markets.
ERIC BILLINGS: Thank you, Brad and good morning.
In today's call we will cover third-quarter results, the
progress of our cost-reduction activities, some franchise-
building steps taken during the quarter, the state of our
balance sheet, and the outlook going forward.
The environment continues to be as challenging
as any we have ever seen. What we are experiencing, in
terms of the nature and severity of the dislocation in
the financial markets as well as the impact on an
increasingly interconnected global economy, is
significant. We expect that the duration of the downturn
will be prolonged and will continue to have a negative
impact on banking and the securities industry.
Our third-quarter results are clearly a
reflection of the difficult capital markets environment.
The firm reported a $28.6 million or 44 cent per share
third-quarter loss, compared to what was essentially a
break-even third quarter in 2007.
Our loss for the quarter includes
non-operating charges of $3.7 million for severance costs
and $11 million for valuation adjustments to merchant
banking and other long-term investments. Excluding these
charges, and $5.5 million of non-cash equity
compensation, the operating cash loss would have been
approximately $16 million after tax.
In response to the increasingly difficult
economic climate, we undertook a second head count
reduction in August and implemented an aggressive cost-
cutting program which, when fully realized, will reduce
our annualized breakeven by approximately $125 million
over our second quarter run rate, creating a cost
structure where we expect to breakeven, in spite of these
historically low levels of banking revenues.
During the third quarter we achieved
approximately 20 percent of the fixed-cost reductions
that we have targeted to get us to our reduced
breakeven. The initial impact of these reductions was
sufficient to achieve cash breakeven for the month of
September. We expect to achieve 60 percent of the target
savings in the fourth quarter, with the full savings to
be realized in 2009.
Some of the more significant cost-reduction
initiatives being taken include, reductions in domestic
and international head count, decrease in the scope of
FBR sponsored events and marketing activities,
consolidation of facilities, and elimination of certain
technology costs.
Overall we are targeting a $30 million
reduction in annual fixed costs and additional
improvements in our breakeven through adjustments to our
variable costs.
Subsequent to the quarter's end, the Company
repurchased 6.7 million shares at an average cost of
$5.02. As a result of this repurchase activity, which
includes 1.5 million shares set aside for potential
employee purchase, book value per share now stands at
$7.13.
Investment banking revenues were $12.8 million
compared to $8.2 million in the second quarter. Clearly,
primary capital markets continue to be challenging.
In this type of environment, our focused
equity capital markets model has always exhibited
volatility, as evidenced by the quarter's results.
Conversely, during the market downturns, fast moving
capital-raising capabilities -- one of the primary
strengths of our firm -- are of paramount
importance. We believe that with the platform we have
today, and with -- because of the severity of the
economic climate, as soon as conditions permit, we are
likely to participate in significant numbers of
recapitalizations across various industry segments, and
in particularly in financial services -- an area of
historic strength for our firm.
Our institutional brokerage business
maintained its strong upward trend during the quarter, as
we were able to take advantage of the dislocations in our
industry. Brokerage revenues were $36.4 million compared
with $34.8 million for the second quarter of 2008; and
$27.2 million for the third quarter of 2007, a year-over-
year increase of 34 percent. For the first nine months
of 2008, institutional brokerage revenues were $103
million, 20 percent above the same period in 2007.
As we assess the competitive landscape, the
totality of the recent changes are so significant and
dramatic, it is difficult to fully comprehend. What
we do know is, that our top four equity capital markets
competitors going into 2008 were Bear Stearns, Lehman
Brothers, Wachovia and Bank of America. And what we also
know is that this picture has changed forever. Our
objective is to take full advantage of the current
turmoil, to be in the market and make sure we are fully
engaged with all of our clients and prospects in a way
that maximizes our chances of capturing more than our
fair share of business now and as the market turns.
As we have said in the past, we will continue
to make strategic hires, having added 30-plus
professionals in the last six months, and acquire or fund
businesses that are additive to our franchise, like the
new convertibles unit that we announced last quarter, and
which began trading in September. At the same time,
however, as evidenced by our cost-cutting actions, we are
proceeding with caution as we believe the break in the
financial markets are likely to persist for some time.
As history has shown, difficult market conditions present
opportunities for us to take advantage of our unique
strengths and capabilities.
With regard to our balance sheet, first and
foremost, it remains relative to our size, the strongest
in the industry. As mentioned in our release at the end
of the quarter, we reported 450 million of capital, all
equity.
FBR Capital Markets is a firm that has
historically performed well in challenging environments.
With substantial balance sheet strengths, our franchise
is as strong as it has ever been. The execution of the
previously outlined activities to reduce costs and expand
our capabilities, along with our flexibility and
adaptability as a firm, will lead to reduced volatility
and a return to significant profitability as we take
advantage of the environment and the inevitable recovery.
We will now open the call to questions.
OPERATOR: At this time I would like to remind
everyone, in order to ask a question, press star and the
number one on your telephone keypad. We'll pause for
just a moment to compile the Q and A roster.
Your first question comes from Eric Bertrand
of Barclay's Capital.
ERIC BERTRAND: (INADUIBLE) meaningfully participate in
the capitalization of the bank sector, how do you think about
that opportunity, given the context of the TARP Capital
Purchase Program where the Treasury is actually directly
investing in banks?
ERIC BILLINGS: So, Eric, obviously
that's a good question. And I think it's not clear to
anybody at this time what the exact ramifications will be
in this regard.
Having said that, I would tell you from my
perspective, I think that it will probably, in some ways,
enhance the ability to raise capital for many of these
companies. And the reason I say that is twofold. Number
one, this capital, remember, is trust preferred --
or a preferred capital. It is long-term financing. It
is not common, tangible equity. When these companies --
all of them -- when they lose money, they lose money
through their common, tangible equity. So, in point of fact
what the government is doing, the TARP Program is increasing
the funding of long-term debt on these balance sheets.
It is not, in fact, increasing the tangible, common
equity. And this is of paramount importance.
I think there's going to be opportunity to
talk to many of these companies and to do, potentially,
transactions that can be simultaneous, take down to the
government TARP plan, and simultaneously increase and
raise equity capital at prices that on their
behalf may not be as severe as they otherwise would have,
and still will enhance the value of the franchise and
create a great investment opportunity, as people
functionally are buying into great funding sources,
deposit bases, which obviously are the greatest value
they've ever had because of the break in the capital
market.
So, I think there's going to be many hundreds of
failed banks. The TARP Program is not going to prevent
that under any circumstance from our perspective. And the
opportunity to capitalize and recapitalize financial
institutions will be very, very significant.
ERIC BERTRAND: Okay. Thanks. The
investments securities portfolio, it took, you know, it
looks about an $11 million loss this quarter versus pretty
much nothing last quarter and a little bit in the prior
quarters.
Are there any specific securities in that
portfolio that generated a losses this quarter?
How should we think about the positioning
of the whole portfolio?
RICHARD HENDRIX: Eric, this is Rick. You
know we don't disclose the individual securities that we
write down or we take gains on until the Q is out.
And, so, everybody will have an opportunity to
kind of see where that portfolio stands when
we file, but we don't disclose prior to that.
ERIC BERTRAND: Okay. Could you say whether
there were, any exposures to the GSEs or the
failed broker dealer last quarter?
RICHARD HENDRIX: There were no exposures to
either of those activities. We actually did have --
and we kind of alluded to this in the press release --
we had one floating rate agency mortgage security that
was on repo at Lehman when it failed. Because as you know,
we run a lot of cash and low leverage, we were able to,
essentially buy that security back during the week between
when the holding company filed and when the subsidiary filed
the following weekend; and then held the security in cash
over quarter end and refinanced it with another repo
party in early October. So, that was the only potential
exposure to Lehman. And, we didn't have any
negative impact from it.
ERIC BERTRAND: Okay. Fair enough. And then
one more question before I hop back in the queue. On the
asset management business, actually, you talk about the
flows during the quarter and said it's a strategic initiative
in the business. Seems like the business continues to
be performing rather low level. We're looking for some
sort of development there.
RICHARD HENDRIX: Sure. So,in terms of flows,
we aren't any different than any other mutual fund firm,
in the sense that we've had negative flows in the aggregate.
Most of that has come in kind of our biggest fund,
which is the FBR Focus Fund. And inside of those numbers
we've actually seen positive flows into our financial
services funds, particularly of late, as investors are
looking at that as an opportunity. And the relative
performance of all the funds continues to be in the very
high percentiles of their peer group. So, while this is
a difficult environment and nobody should be pleased with
negative returns just because you're in the top percentile,
some of these funds are new, as we've talked about and are
getting ready to reach their three-year point. And their
performance is going to generate very high rankings within
the mutual fund group. So, we think we'll see positive
flows when they return to the industry overall. But we
certainly are not immune to the overall outflow that has
taken place in the industry.
And we do have some opportunities that we're
pursuing for organic growth in that business overall.
And rather than get into each of those individually,
those are things, hopefully, we can talk about
in coming quarters.
ERIC BERTRAND: Okay. Fair enough. I'll hop
back in the queue. Thanks.
OPERATOR: Again, if you would like to ask a
question, press star then the number one on your
telephone keypad. We'll pause for just a moment to
compile the Q and A roster.
Your next question comes from the line of Dan
Fannon of Jeffries.
DAN FANNON: I wanted to talk a bit about
the areas of strength, when you say the market
comes back, that you guys see and think you're well
positioned. I think the banks would make sense, in terms
of what we're seeing for capital raises. But what other
areas do you see, that when you talk to your clients,
that you think, when the capital markets do open up, that
you're well-positioned to benefit from activity in?
ERIC BILLINGS: So, Dan, I think that the backlog
of the activity that we have is building in a very robust
way. Obviously one of the things that people should keep
in mind, is that the capital markets have been now for
months, equity capital raising has been almost shut down.
I mean, virtually unprecedented. And, small cap companies,
growth companies, that we obviously focus on, they are,
users of capital. They need equity capital.
And, so, the fact that they have not had
access doesn't mean that they suddenly don't need it, it
means that it's being delayed. But when they have
access, again, they're going to robustly access the
equity capital markets. And, so, you know, whether
the entire figure is for banking, structured finance,
the opportunity I think will be enormous. I think that,
certainly we're seeing it in our diversified
industries area, our insurance area, our energy area. We
have -- it's a little bit different because of some
circumstances, but we have numerous transactions that we're
looking at there. And, so, I'd say really it's quite
pervasive and I think we'll see activities across the
board. And I think you'll see that our ability a la
things like the National Bank holding company vehicle
that we're creating; these vehicles will
allow us to raise capital sooner than when the markets
actually come back and reopen on a general basis, and --
which is assuming our history. But -- I think we'll be
able to access it more quickly. And then I do believe,
as the markets open more broadly, we'll have a very
broad, you know, amount of capital raising activities.
DAN FANNON: And given some of the struggles
of what were, you know, used to be your competitors or
with the general kind of investment banking market, are
your dialogues changing? Are you talking to bigger
companies? Or are you -- the doors being opened to
people that you necessarily weren't seeing or talking
with before?
RICHARD HENDRIX: You know, Dan -- this is
Rick. I would say, it's not so much that we're
talking to people that we weren't talking to before,
although I think that probably is a longer-term
development that will be the case. But all of a sudden,
we are having a different level of competition,
and in a lot of cases different dialogues with our
existing clients. And, so, whereas we did a
deal in the third quarter that we would have co-booked
with one of the bulge bracket firms,just
kind of based on history with that client. And prior to,
you know, some of the extreme dislocation with that
particular company, the client, had us sole
book the transaction. And we have transactions where we
would have been a co-manager clearly, where we are now a
book running manager.
And, in some cases we are moving to the left of, the
biggest names in the industry. And that is, because of
a number of things. It's because of concern specifically
with some of the guys that you know met with the most
severe disruptions. But it also is a function of the
fact that, we are getting our most senior resources in front
of these clients. And, so, the remaining large firms,
in our opinion, are meaningfully distracted. And,
we think we're getting better resources, better ideas
in front of our clients and the clients are responding to that.
Now, as Eric said, the market is clearly not open,
but our backlog is very solid. It's very solid across all
of our industry groups. We clearly need, as everybody does,
kind of a window to be able to execute. But our relative
positioning with our existing client base, isn't
about to change; it has changed. And I don't think we'll be
solely unique in that. I think other of the midsized,
peer firms should benefit from the same kind of activity.
DAN FANNON: Okay. Great. Thank you.
ERIC BILLINGS: Thanks, Dan.
OPERATOR: Again, if you would like to ask a
question, press star then the number one on your
telephone keypad. We'll pause for just a moment to
compile the Q and A roster.
There are no further questions at this
time. I would now like to turn the call back over to
Eric Billings, CEO for any closing remarks.
ERIC BILLINGS: Thank you everybody for
joining us. We appreciate it and look forward to
speaking with you next quarter.
OPERATOR: This concludes today's conference
call. You may now disconnect.
(Whereupon the conference call was concluded.)
