EXHIBIT 99.1
Friedman, Billings, Ramsey Group, Inc.
Fourth Quarter Earnings Conference Call
February 5, 2004
Facilitator:
Ladies and gentlemen, this is the operator. Today's conference is scheduled to
begin momentarily. Until that time, your lines will again play music. Thank you
for your patience.
Good morning. My name is Kristi, and I'll be your conference facilitator today.
At this time, I would like to welcome everyone to the fourth quarter 2003
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 period. If you
would like to ask a question during this time, simply press "star "and the
number "1" on your telephone keypad. If you'd like to withdraw your question,
press "star" and the number "2" on your telephone.
Thank you. I will now turn the call over to Mr. Harrington, Chief Financial
Officer. Go ahead, sir.
Kurt Harrington, Chief Financial Officer of Friedman, Billings, Ramsey Group,
Inc.:
Thank you. Good morning. This is Kurt Harrington, Chief Financial Officer of
Friedman, Billings, Ramsey Group, Inc.
Before we begin this morning's earnings 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 the secondary
securities markets, interest rates, our cost of borrowing, interest spreads,
mortgage prepayment speeds, 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
Group's Annual Report on Form 10-K and quarterly reports on Form 10-Q.
I would now like to turn over the call to FBR Group's Co-Chairmen and Co-Chief
Executive Officers, Emanuel Friedman and Eric Billings. Also joining us this
morning are Robert Smith, FBR's Chief Operating Officer, Rock Tonkel, Head of
Investment Banking, and Rick Hendrix, Chief Investment Officer.
Emanuel Friedman, Co-Chairman and Co-CEO, Friedman, Billings, Ramsey Group,
Inc.:
Thank you and good morning. Last night we announced our December quarter and
year end 2003 results. 2003 was a very eventful and profitable year for FBR and
our shareholders. We took numerous actions to prepare ourselves for future
profitability and growth, in line with 2003 results.
One, we strengthened and consolidated the entire FBR platform by merging our two
companies.Two, we increased corporate liquidity through the creation of
Georgetown Funding, a $5 billion commercial conduit program. Three, we further
strengthened our balance sheet by completing a $450 million follow-on equity
offering in October, increasing our shareholders' equity to $1,554 million.
Four, we began a campaign to increase our brand awareness and corporate
notoriety, including the recently completed FBR Open in Phoenix. We grew every
line of our business profitably, while taking steps to broaden our platform and
position it for sustained, prudent and profitable growth. Finally, we set
company records for revenue and profitability.
The earnings we reported last night are what we believe are the beginning
results of our efforts I just mentioned. We also achieved revenue and
profitability records in nearly every business line in the fourth quarter.
Net income was $201.4 million, or a $1.68 per basic share, and $1.63 per diluted
share for 2003, compared to $53.3 million or a $1.16 per basic share and $1.10
per diluted share for 2002. For the fourth quarter of 2003, net income was $80
million, or $0.50 per basic share, and $0.49 per diluted share, compared to
$10.1 million or $0.22 per basic share and $0.21 per diluted share for the
fourth quarter of 2002.
Adjusting for the impact of purchase accounting adjustments on asset yields and
cost of funds resulting from our merger with FBR Asset Investment Corporation,
the full year diluted earnings per share of $1.63 would increase by $0.10 to
$1.73, and the fourth quarter diluted earnings per share of $0.49 would increase
by $0.01 to $0.50.
We declared a quarterly dividend of $0.34 per share on December 11, 2003, to
shareholders of record as of December 31, 2003. For the full year, we declared a
total of a $1.36 per share in dividends and increased our book value per share
by 78%, from $5.28 at December 31, 2002 to $9.41 at December 31, 2003. The
dividends and increase in book value per share provided a 104% total return on
equity to shareholders in 2003.
Our fourth quarter reflected continued strong performance in our capital markets
business and a recovery of the net interest margin in our mortgage-backed
securities portfolio as the extremely high prepayment speeds in the third
quarter moderated significantly in the last three months of 2003.
All of our businesses are positioned well for future growth and have begun to
see the results of this positioning.
We achieved record earnings during the quarter despite running lower than our
targeted leverage in the mortgage-backed portfolio as we invested proceeds from
the $450 million follow-on offering in October. Additionally, we chose not to
realize any gains in our $261 million merchant banking portfolio during the
quarter. Unrealized gains, however, did increase $45.3 million during the
quarter and totaled $96 million at year-end.
2003 full year investment banking revenues totaled $278.6 million, versus $143.9
million in 2002 and ended up almost double our original projection of $150
million. In fact, our fourth quarter total of $127.8 million was close to the
original projection for the entire year.
Our institutional brokerage revenues totaled $74.1 million during 2003, an
increase of 17% over the 2002 total of $63.2 million. For the fourth quarter of
2003, institutional brokerage revenue totaled $23.5 million, versus $14.7
million during the fourth quarter of 2002, an increase of 60%. These results
were achieved despite the continuation of industry-wide pricing pressure in this
part of the business. Illustrating this market condition is the fact that our
customer share trading volume increased 32% year over year.
Our asset management business also performed well during the year. Assets under
management increased in both our mutual fund and hedge fund businesses. Net
assets under management, excluding FBR Asset prior to the merger, increased
34.3% percent year over year. Total fee revenues from the asset management
business increased by 48.6%, to $30.4 million in 2003, from $24.4 million in
2002, again excluding the impact of FBR Asset.
Our overall 2003 and fourth quarter performance was reflective of what we
believe is the beginning of a sustained period of growth, driven by the strength
and flexibility of our balance sheet, the positioning of our existing business
lines, continuing growth in our client relationships, and our entry into
additional businesses which take advantage of our existing infrastructure.
Now I would like to hand the call over to Eric Billings, who will discuss our
results in more detail and our outlook for the future.
Eric Billings, Co-Chairman and Co-CEO, Friedman, Billings, Ramsey Group, Inc.:
Thanks, Manny.
Before we go through the detail of our five profit centers, I would like to talk
a little about how we have positioned and will continue to build each of our
businesses. As we have stated on previous calls, we make investments and
underwriting judgments based on an analysis of intrinsic value of businesses,
with a strong emphasis on optimized capital structures. We apply this discipline
in all facets of our business and use this, along with an emphasis on execution,
as the basis for our corporate culture. Of course, we use this discipline in
managing FBR for our shareholders as well.
It is our belief that this approach is responsible for many outstanding track
records within FBR, including the aftermarket performance of all of our public
equity offerings over the last five years, which ranks #1 among all major
underwriters, the historical annualized performance of our merchant banking
portfolio, which has returned an un-leveraged 36% IRR since its inception in
1997, the performance and rating of our five FBR equity mutual funds, three of
which are five star ranked by Morningstar; and the strong performance of our
private investment partnerships.
We believe that through this unwavering investment discipline in all of our
business lines and by maintaining a disciplined expense structure, we will
continue to expand our franchise and create additional wealth for our
shareholders.
Our capital markets franchise continues to reflect the results of this
discipline. We have finished the year as the #3 lead manager of U.S. IPOs, the
#10 lead manager for U.S. public equity offerings, and the #1 performing major
underwriter as measured by the after-market performance of our lead underwritten
equity transactions during 2003, continuing our five year track record mentioned
earlier.
Our transaction volume has grown from $2.5 billion in lead managed capital
raises in 2002 to $6.5 billion in 2003. Our fourth quarter lead managed capital
raises were $3.1 billion versus $269 million in the fourth quarter last year,
and $2.1 billion in the third quarter of this year.
During the fourth quarter, we completed 6 IPOs, 7 follow-on offerings, and 3
private equity placements, representing over $3.0 billion in total dollars
raised. Our fourth quarter investment banking revenues were a $127.8 million,
versus $24.3 million in the same quarter last year.
In previous quarters we have talked about our lead managed equity and M & A
pipeline, which was approximately $3.5 billion in the first quarter and grew to
$5.0 billion last quarter. Today this pipeline continues to be in excess of $5.0
billion despite our record fourth quarter underwriting levels.
Our capital markets and institutional brokerage businesses have achieved
compounded annual growth rates since 1999 of 54% and 19% respectively. This has
been achieved despite a general lack of recognition within our markets of the
capability and strengths of our franchise. We are optimistic that as we begin to
achieve greater franchise recognition throughout corporate America, which we
believe to date has little awareness of FBR, both our investment banking and our
institutional brokerage businesses will continue to achieve increases in market
share for the foreseeable future.
Turning to our balance sheet businesses, I would like to first address our
mortgage-backed security strategy. At December 31, 2003, the fair value of our
mortgage-backed security portfolio totaled $10.6 billion, and our corresponding
repurchase agreement and commercial paper liabilities, including Georgetown
funding, were $9.5 billion.
2003 was a year that included some volatile periods for these securities, and we
believe our performance shows that we have the discipline to maintain that
strategy in all environments and can achieve outstanding returns in different
markets. Preservation of capital is our guiding principle, and like our other
businesses, we focus on an appropriate capital structure, which means low
leverage and an intrinsic value approach to the risks we take.
For the mortgage-backed security portfolio, this approach means specifically
that we focus heavily on maintaining significant liquidity to be able to finance
our portfolio through virtually all market environments. This focus takes
several forms--we maintain low leverage for this asset class, we maintain low
duration to limit interest rate risk and related price volatility, we finance
this portfolio efficiently through multiple counterparties and Georgetown
Funding, our dedicated A1-P1 commercial paper program, and we maintain
significant liquidity in the form of our other investments and borrowing
capacity away from the portfolio.
In addition to our focus on liquidity and capital preservation, we also protect
our expected current income through the use of interest rate swaps. Currently,
we have $5.1 billion, or approximately 53% of our floating rate liabilities,
swapped to fixed rates for an average term of almost one year, providing
significant protection against short-term interest rate increases.
For the fourth quarter, our mortgage-backed securities portfolio asset yield was
3.23% and the company's weighted average financing rate was 1.21%, resulting in
a net interest spread of 2.02%, versus 1.69% for the year and 1.25% for the
third quarter. These net interest spreads would have been 2.14% and 1.91%
respectively, adjusting for the excess amortization from the merger. On the
third quarter call we mentioned our forecast that spreads would return to more
normalized levels in the fourth quarter. In fact, the spread in the fourth
quarter was 77 basis points higher in the fourth quarter than the third quarter,
as asset yields improved due to falling CPRs. The company experienced an average
one-year CPR, or constant prepayment rate, of 27 during the quarter, down from
41 during the third quarter. The return to a more normalized spread demonstrates
the resiliency of the company's mortgage-backed security business given the
extreme conditions of the third quarter.
For our merchant banking investments, we use a highly disciplined approach, in
which we thoroughly analyze all aspects of a company's business to ensure
investments in companies that achieve high cash returns on risk-adjusted
capital. Further, as part of our larger balance sheet discipline, we measure
every merchant banking investment continuously against the returns we achieve in
the mortgage-backed securities portfolio on a risk-adjusted basis. Thus, we
expect the long-term performance of this portfolio to exceed returns in the
mortgage-backed security strategy. This has held true in the past, with the
merchant banking portfolio achieving a 36% unlevered IRR since inception,
although these results will vary from quarter to quarter.
FBR's merchant banking portfolio and other long term investments totaled $379.0
million at the end of the quarter. This is 24% of the company's equity and
approximately equal as a percentage of equity to our third quarter level before
the capital raise in October. We believe there are opportunities far exceeding
our funding capability to invest in transactions in keeping with our strategy
and are therefore optimistic about our ability to continue our outstanding
record in this area.
Finally, we have alluded to our efforts to increase our corporate notoriety and
brand awareness. Last year we sponsored the FBR Capital Open as an initial step
in this direction. On a longer term basis, last week we sponsored the FBR Open
for the first year of a five-year commitment to this popular and storied PGA
tour tournament in Scottsdale, Arizona. This is the largest spectator golf
tournament in the world, which was formerly known as the Phoenix Open. This
tournament was a great success for FBR and the Phoenix area charities. Over a
half a million people attended the event and over $3 million will be given to
charity. We also used this event as an opportunity to develop an even closer
relationship with our clients, whom we value as the backbone of our business.
Our sponsorship of the FBR Open will continue through 2008, and it will be the
centerpiece of our brand building and corporate entertainment for the
foreseeable future.
Concurrent with the FBR Open, we launched a national advertising campaign,
including TV, print and online. Our objective, as with the FBR Open, is to
increase our name recognition, building on the momentum of the tournament and
our strong 2003 financial performance. Our research shows that our brand
awareness is so low that even a modest gain should translate into an appreciable
number of new engagement opportunities.
We believe that we have now built a platform which has multiple businesses
positioned for growth, a disciplined investment strategy, a lean cost structure,
prospects for growing brand awareness and a strong and flexible balance sheet.
Hence, we are very optimistic that the outlook for 2004 and beyond includes the
opportunity for both increased profitability and dividends.
Specifically, as we update our model to reflect current revenue run rates, we
can share with you how we view our prospects for 2004. As we have stated in the
past, when talking about our model, keep in mind that this is not a projection
and that results will vary from this model, especially quarter to quarter,
particularly in investment banking.
It is reasonable, though, to now look at revenue rates for our investment
banking businesses achieved during the second half of 2003, combined with the
current ramp level in secondary institutional sales, as the basis for our model.
This would imply investment banking revenues of $400 million, with sales and
trading revenues of $125 million, for total capital market revenues of
approximately $525 million. In response to this new level of business and
anticipated future growth, our top initiative this year is fully building out
all areas of our current sales, trading, research, and investment banking
businesses. We anticipate that the largest areas of growth will be in the
healthcare, consumer and technology sectors, where we have made significant
market share gains a top focus this year. We expect great success in these
areas, similar to other industry groups where we have hired top professionals
and focused our energies in the past. We expect that with this added breadth,
our break-even level for the capital markets businesses will increase to
approximately $200 million, with 27% after-tax margins on revenues above these
levels. Hence, we believe this business could reasonably contribute
approximately $85 million of after-tax earnings in 2004.
It should be noted that we measure every increase in cost against future revenue
and cash flow for increasing margins. This model would result in an increase in
after-tax margins while still allowing for increases in revenues and margins off
of this break-even base.
As we have stated before on previous earnings calls, you can model your own MBS
spreads, but we use 220 basis points, our estimate of the 20 year average, with
9.5 times leverage in a $10.5 billion portfolio which, after 10% estimated
costs, would yield earnings of approximately $220 million. Our other principal
activities, we estimate, could yield approximately $68 million after 10%
operating expenses on approximately $380 million of invested capital, well
within our historical return results from these assets.
In addition, we estimate our run rate in asset management fee revenues to be
close to $40 million, which would generate about $7 million of after-tax
earnings. This model would generate approximately $380 million of after-tax
earnings in 2004, with approximately $280 million being generated in the REIT
holding company and available for dividends.
Again, this is a model. Break-even points and marginal contributions will vary
with revenue mix and timing of expenses. Our actual results are subject to the
risks and uncertainties inherent in our business.
I would now like to open the call for any questions.
Facilitator:
At this time, I would like to remind everyone, in order to ask a question,
please press star-one on your telephone keypad. We'll pause for just a moment to
compile a Q&A roster. [Pause]
Your first question comes form Mike Flanagan, Securities Industry Analyst.
Mike Flanagan, Securities Industry Analyst:
Good morning. Two questions on, I guess they're looking forward more. Given your
optimism for the 2004 operating results, how might this impact your dividend,
which is currently $1.36 annually? And secondly, given your success in the IPO
markets in 2003, are you sensing increased competitive pressure, especially from
larger firms, and how might this translate into opportunities for you in 2004?
Eric Billings:
Great, Mike. Good questions. Let me clarify--I think on the prepared release, I
indicated that the model would result in $300 million of after-tax
profitability. That number is $380 million, so I want to clarify to everybody,
that number is actually $380 million, not $300 million.
So specifically, Mike, the results of our 2004 model would result in a dividend
of approximately $1.75. And as we've indicated in the past, it is our
anticipation that we will pay two special dividends on a semi-annual basis this
year for the dividend amounts that would exceed $1.36. And certainly our current
planned model as we look at 2004 would strongly suggest to us that these are
achievable.
Emanuel Friedman:
In terms of the IPO market in a competitive environment, a couple factors - One,
the trends that we set forth in 2003 are continuing in 2004. That is, we've
already completed two IPOs since the beginning of the year. They both had very,
very strong performance, so we rank at the top of both IPO performance and the
number of IPOs completed. We have two more IPOs filed right now and companies
are coming to us on other transactions and other groups given the strength of
our results in 2003, including diversified industries, energy, technology and
across all our verticals. Even though the competitive environment certainly has
increased, we're confident about maintaining our pace in 2004.
Mike Flanagan:
Thank you very much.
Facilitator:
Your next question comes from Mark Atlas of Centurion [ph].
Mark Alpert, Centurion:
Good morning. I actually have three questions. Number one, how much of the $5
billion in backlog have you done year to date in equity deals and M&A? And
number two is, could you talk about where the unrealized gains in merchant
banking came from a little bit and when they might be realized? And then the
third is a little more complicated, and that is just a kind of clarification of
the rules, you know, regarding a TRS and what percentage of earnings you can
have coming from outside of the REIT?
Emanuel Friedman:
Concerning our backlog, the backlog that we stated is an unrealized backlog. It
doesn't include anything that we've already done.
Mark Alpert:
It says in the press release that going into the, leading into 2004...
Emanuel Friedman:
I would say that as fast as we are doing transactions, we are getting new
transactions being signed up, so the backlog continues to run at, in excess of
the $5 billion dollar run rate.
Mark Alpert:
And so then what have you done already in January
Emanuel Friedman:
In...
Mark Alpert:
In IPOs, if nothing else--lead managed.
Emanuel Friedman:
We've completed two lead-managed IPOs in January so far, but that backlog refers
to secondaries also.
Mark Alpert:
Oh, okay. And the merchant banking gains, where did they come from, when are
they realized?
Eric Billings:
The way we run the merchant banking portfolio, very specifically, is we measure
all investments against our mortgage-backed securities strategy, which has
historically and we believe will continue on average to produce approximately
22% - 23% returns on invested equity.
By definition, all investments we make have more risk than the MBS portfolio
returns of 22%-23%. We don't leverage any other part of the balance sheet in the
company, so we monitor these other investments on a quarterly basis. We evaluate
whether we can achieve a higher risk-adjusted return in the next four quarters,
depending on the particular investment returns which are in the 30% rate or
higher. If we don't believe that a particular investment can achieve these
return levels, then we will sell that investment and redeploy that capital in
the mortgage-backed security portfolio.
And so, specifically, we do have substantial unrealized gains. Clearly, when we
recognize these gains is not precise. It is likely that we will recognize gains
this year and we certainly believe that we'll take gains that would be equal to
our targeted gains which is approximately $70 million for the year. Having said
that, you know, these things are not completely predictable.
Mark Alpert:
No, I guess what I'm more interested in is, you know, is the increase of $45
million, I guess, in the quarter. You know, is that one or two investments where
that could swing the other way? Is it pretty broad-based?
Eric Billings:
It's very broad-based, Mark. We have gains in every investment that we have in
the fourth quarter and the gains have been growing fairly consistently through
the year.
Richard J. Hendrix, Chief Investment Officer, FBR:
Mark, this is Rick Hendrix. We'd like this to be as transparent as possible for
our investors, but as we said in previous calls, we don't discuss what we've
sold during any quarter. But since we took no gains, I think it's safe to assume
we didn't sell anything in the fourth quarter, and you can look at the list of
investments in the third quarter, and where they were marked, and actually come
up with the gain.
Mark Alpert:
Okay, thank you. And then in terms of the rules regarding--you know, could you
just run quickly over what you do pay on the dividend above, you know, above the
REIT, and aren't there rules that kind of dictate what you have to pay out in
the dividend?
Richard Hendrix:
The rules relate specifically to the earnings generated in the REIT. I think
your initial question is the limit of the income that can be generated in the
TRS? There is no practical limit. The limits with regard to the TRS, the Taxable
REIT Subsidiary, have to do with the value of that subsidiary against the total
value of your assets for the whole company.
So as long as we retain the income in the Taxable REIT Subsidiary, there's no
real limit on how much earnings we can generate there. Now, we do pay tax on
those earnings.
Mark Alpert:
Okay.
Richard Hendrix:
Okay? So we'll pay the dividend, and our policy is to pay virtually a 100% of
the earnings generated to the REIT in the form of a dividend.
Eric Billings:
And as our 2004 model suggests, approximately $280 million of our earnings could
be applied to the dividend and approximately a $100 million would be retained in
the Taxable REIT Subsidiary the broker dealer, and we would utilize that capital
to grow the business. The capital would then most probably be upstreamed to the
REIT and thereby earn what we believe on a long-term basis is approximately a
22% incremental return.
Mark Alpert:
Right.
Emanuel Friedman:
Keep in mind, we're a full taxpayer, as a TRS.
Mark Alpert:
Right.
Emanuel Friedman:
We paid over $45 million of taxes in 2003.
Mark Alpert:
Okay, but the dividend payment rate is $1.36, and then you expect to have two
special dividends, correct?
Emanuel Friedman:
Correct.
Mark Alpert:
The $280 million that the REIT earns...
Richard Hendrix:
Right.
Mark Alpert:
Doesn't that basically all have to get paid out?
Richard Hendrix:
Yes, it does. Based on our policy and to the extent that our earnings exceed
$1.36, we would intend to pay the excess in special dividends, and ideally we
would do that in two special dividends throughout the year.
Mark Alpert:
Okay. And then none of the, and none of the $100 million would--what about
merchant banking, or gains? Would those ever go to pay a dividend, or is it all
just what the REIT earns?
Richard Hendrix:
The merchant banking gains are primarily in the REIT.
Mark Alpert:
Oh, okay.
Richard Hendrix:
And it would go to pay dividends, but the earnings, as a Taxable REIT
Subsidiary, primarily the broker dealer and the asset management unit, are fully
retained.
Mark Alpert:
Okay. Are potential merchant banking gains included in your outlook or is that
strictly the MBS? That's strictly the MBS, wasn't it?
Richard Hendrix:
No, the $280 million includes gains from merchant banking business.
Mark Alpert:
Okay. All right. Thank you very much.
Eric Billings:
Thank you.
Facilitator:
Your next question comes from Howard Feingold of Raymond James.
Howard Feingold, Raymond James:
Thank you. Congratulations on your quarter, guys.
Eric Billings:
Thank you, Howard.
Howard Feingold:
I have three questions. Did the $1.36 that you paid in dividends for '03 exceed
the taxable earnings on the REIT itself?
Eric Billings:
Go ahead, Kurt.
Kurt Harrington:
Yes. There was a slight distribution in excess of the earnings. It resulted
primarily in the first quarter, when we paid out a dividend to all post-merger
shareholders, versus three quarters worth of REIT earnings for the combined
group.
Eric Billings:
Specifically, the only overage we've paid was as a result of the merger in the
first quarter which came from the REIT earnings.
Howard Feingold:
I understand that. My real question is on the taxability to the shareholders on
the $1.36. Is any portion of that going to be either nontaxable or qualified
taxable dividend?
Kurt Harrington:
94.5% is taxable ordinary income to the shareholders. 3.04% is qualified
dividends...
Howard Feingold:
Qualified? Okay.
Kurt Harrington:
The qualified dividends also fall under the new 15% percent tax rule. 2.01% are
post-May 5th capital gains, which also qualify for the 15% percent new tax rule,
and 0.45% were pre-May 6th capital gains, which fall under the old capital gain
rates.
Howard Feingold:
Okay. All right. Thanks very much. Secondly, if you could offer some guidance
here in terms of current share price and book value, an additional add-on
offering would certainly be accretive to your book and probably certainly to the
earnings in the MBS, and you also alluded to the fact that you have more
opportunities in the capital market than you can fund at this point. At what
point would you be looking to do an additional raise?
Eric Billings:
We have a very, very disciplined approach. Anything we do inside the business,
actually anything at all, but particularly as it relates to capital activities,
must be accretive to earnings, book value, dividends, and the intrinsic value of
the business in order for us to raise additional capital. Or for instance to buy
back stock, both of which in times, historically, in the two different
companies, when FBR Asset and FBR Group were separate businesses, we have done
from time to time.
So we monitor these things very carefully, and when we believe we can achieve
these results and that capability, then we will do that. But clearly, a very
large part of it is that we believe we can deploy the capital we retain in a
basis which is accretive to earnings and the dividend, and therefore we must
believe that the environment is suitable for us to allocate capital in our
mortgage-backed securities portfolio and most probably in our merchant banking
portfolio, and/or possibly in strategic alternatives that may be appropriate.
And when those are available, then we would intend to execute against that.
Howard Feingold:
Okay. Last question--several months ago you made an announcement that you were
going to enter the sub-prime market. Could you give us some kind of description
about that part of your business?
Richard Hendrix:
Sure, Howard. Specifically, what we talked about was the addition of a group of
professionals to focus on the asset-backed securities, ABS, component of the
sub-prime market. We actually have been involved with three transactions to date
since that group joined us, and they're in the process of expanding that
business. They brought to us several relationships, and as you probably know, we
have many relationships from our investment banking business in that sector. The
ABS team is doing a great job for us and we hope that they continue to grow
aggressively in '04.
Emanuel Friedman:
And that covers not just the sub-prime market, but really, financial services.
Howard Feingold:
Basically, what you're doing in that market is securitizing loans and financing
it, or...?
Richard Hendrix:
We are acting as an underwriter and placement agent from a securitization
perspective.
Howard Feingold:
Okay. Thank you very much, gentlemen.
Facilitator:
Your next question comes from Joe Stieven of Stifel, Nicolaus & Company.
Joe Stieven, Stifel, Nicolaus & Company:
Hi, guys. First of all, great quarter and year. Most of my questions have been
answered, but I'll ask a couple. Number one, your asset management business was
much more profitable in the fourth quarter than I think you guys have previously
talked about, and even when you talk about '04, it seems like you're being very
conservative with your thoughts for that. So that's one--why was it so
profitable in the quarter, talk about that.
Number two is that when I look at the MBS portfolio with the concept of
potentially rising rates, any thoughts or any changes in your strategy on what
you're trying to do? I obviously see you're trying to fix more and more of your
liabilities out there. Thanks, guys. I'll sit back and listen.
Emanuel Friedman:
In terms of the asset management, what was driving it was three factors. One,
we've had steady inflows. Number two, the mutual funds and the alternative
assets, incentive fees were substantial in the fourth quarter and began to kick
in for the entire year. So the two major factors were the growth of the business
and significant incentive fees. We see those trends continuing in 2004.
Eric Billings:
Joe, specifically, just a quick comment on asset management. We do believe that
because the historical performance is so strong across the board, the asset
management business has been so strong and as we, on a more focused,
conservative basis, go after capital to invest in our asset management business,
we will have significant success. And we are optimistic that we can build that
to be a substantial profit center for the company.
The question on the mortgage-backed security portfolio-- Absolutely, Joe, great
question, of course, and it's something we think about all the time. And exactly
to your point, we have taken, funded on a liability side of both. 55% percent of
our liabilities are now out approximately a year or longer. In addition, of
course, about 10% of our funding is through our equity capital.
So between our longer term funding on the liability plus our equity capital,
roughly 2/3 of our capital would not be affected by rate movements during the
course of the year. We look at that on what we think is a very balanced basis
from the perspective that even in a pretty sharply upward rate moving market, we
would expect between the repricing activity of our adjustable rate securities
and the refinancing that would still occur even in a rising rate environment,
that we would get back or reprice at least 35% of the asset side of our
portfolio. Therefore, by leaving 35% on a short-term basis, we will allow the
asset side to substantially move up with the cost of financing on the liability
side.
So that we think it's a good balance, it's gives us a good, defensive way to
maintain a spread and earn what we think are very acceptable, very high rates of
return on the equity portfolio, and it's still, of course, low leverage, high
level liquidity so that we can withstand what we believe is virtually any mark
in that portfolio so as to be able to maintain the spread at all times. So
that's the way we run it, Joe, and always have.
Joe Stieven:
One final question. The merchant banking investments were a little bit larger in
the quarter than the last conference call. Is that just primarily due to the
mark to markets?
Richard Hendrix:
It's a combination, Joe, of the unrealized gains of the appreciation portfolio
and new investments that were made in the fourth quarter.
Eric Billings:
And as we indicated, Joe, the opportunity for us to invest in the merchant
banking area right now is extraordinarily good from our perspective, so it's
something that we balance pretty carefully, and certainly one of the reasons we
will recognize gains in the portfolio because the reinvestment opportunity is so
substantial.
Joe Stieven:
Great quarter, guys. Thanks.
Eric Billings:
Thank you, Joe.
Facilitator:
Your next question comes from Randy Saluc of Meisen Bach Capital.
Randy Saluc, Meisen Bach Capital:
Hey, guys. How are you? Just wanted to ask about the investment banking
pipeline.
Emanuel Friedman:
As we said earlier, the investment banking pipeline is very strong, over $5
billion in the pipeline, and the diversity is growing also--it's obviously very
strong in financials and real estate. We've become the most important factor in
hotels now, and our fixed income investment banking pipeline is very strong,
mainly in banks and REITs. We've become an important factor in REITs preferred.
It's also in energy, where we've done a series of very large transactions, and
we're also becoming a bigger factor in technology and diversified industries.
Our brand is starting to really transfer. We just filed a large secondary to
diversified industries.
Eric Billings:
Maybe a little more specific-- The number of transactions that we do every year
continues to grow. Because of the size and magnitude of the company now, the
resources we have vis-a-vis our market cap, our equity base, our earnings base,
our ability to facilitate our corporate clients on a very broad basis, is
allowing us to maintain our corporate relationships virtually in perpetuity.
Therefore, our ability to not only do IPOs but then to do follow-on
activities--secondaries, high-yield transactions, preferred transactions,
advisory transactions--grows with that growing base, which gives us, you know, a
great anticipation for future growth because of that dynamic.
In addition, when we alluded to the fact that we are growing our base of
resources, we will be adding approximately, somewhere between 65 and 100 people
this year. The focus in that regard is in areas that we think have tremendous
transferability and ability for us to grow technology, healthcare, and consumer,
where to date we have had success but not nearly to the level that we've had in
other industry focuses.
We have seen a very strong correlation to our building out industry focuses with
professionals that can generate investment banking business. The correlation is
extremely strong and we're very optimistic that as we do that more thoroughly in
the technology, the healthcare, and the consumer area, we will have comparable
results.
Randy Saluc:
Okay. Well, I thought it was a great quarter. I have one more follow-up
question. I mean, you gave us some numbers in terms of what earnings might be
for different parts of the business. Do you have a sort of a EPS '04 guidance
range or number that you have in mind that you can share with us?
Emanuel Friedman:
We don't, but we gave you what our model says what our earnings look like, and
obviously right now there is 165 million shares outstanding.
Eric Billings:
If you do the math on that, on the model that we went through, it would lead to
approximately $2.30 earnings per share and approximately a $1.75 dividend.
Again, we stress this is a model based on a view, as we look at our business
today, on a historic run-rate activity. And it is only a model, it isn't a
projection, and we want people to have the tools to make your own assumptions on
each component part of our business so they can then make their own judgments as
to what that earnings and/or the dividend would result in.
Randy Saluc:
Good. Thanks.
Eric Billings:
Thank you.
Facilitator:
Your next question comes form Norman Jaffe of Sunova Capital [ph].
Norman Jaffe, Sunova Capital:
Thank you, guys. Great quarter.
Richard Hendrix:
Thanks, Norm.
Norman Jaffe:
I have two questions. One, can you share with us, since the end of the year,
what your unrealized gain might be on the merchant portfolio? And two, did I
hear it right that you said that based upon your model, '04 profits could be in
the $380 million range?
Emanuel Friedman:
That's correct.
Emanuel Friedman:
We did use that as our model, $380 million in profits in '04, based on our
model.
Norman Jaffe:
Okay. And how about the unrealized gains since the year end?
Eric Billings:
We really don't disclose that, Norm, but you can look at the investments. As I
think we've indicated, since we had no gains in the portfolio...
Norman Jaffe:
Right.
Eric Billings:
....it's probably a reasonable assumption that the investments that we had in the
third quarter are the same investments we have today, which is not to say we
didn't make additional investments in the fourth quarter, because in fact we
did.
Norman Jaffe:
Right.
Eric Billings:
Then--you can look at that and reach a conclusion, I think, pretty clearly.
Norman Jaffe:
Okay. Can I just go back, then, to one thing? On each of the business lines, you
were talking very quick and I wasn't typing fast enough. Could I just bounce
these numbers off to make sure I was correct? The investment banking, based upon
your model, you're looking at like $85 million in '04.
Emanuel Friedman:
After tax.
Norman Jaffe:
Okay, fine. And the MBS portfolio was like a $220 million number after tax?
Eric Billings:
That's right.
Norman Jaffe:
And then your principal investments, like, at $68 million after tax?
Eric Billings:
Yes.
Norman Jaffe:
And then the asset management was something like $300 million after tax.
Eric Billings:
$7 million.
Norman Jaffe:
$7 million.
Emanuel Friedman:
And keep in mind, on the merchant baking piece and the mortgage-backed piece,
that's a pre-tax number and after-tax number because it is in the REIT.
Norman Jaffe:
The REIT, okay. And you said the asset was $7 million.
Emanuel Friedman:
Yes.
Norman Jaffe:
Okay.
Emanuel Friedman:
After tax.
Norman Jaffe:
I got that. I got it. Thank you, guys, Great quarter.
Eric Billings:
Thank you.
Facilitator:
Your next question comes from Richard Herr at KBW [ph].
Richard Herr, KBW Asset Management:
Hi. Good morning, guys. Very nice quarter. Just a few questions to start off.
Just curious--the investment banking revenues have grown a lot faster than the
sales and trading. I was wondering if you could kind of walk us through your
strategy on further build-out in the sales and trading?
Eric Billings:
Right, absolutely. In fact, a significant part of the growth in our cost base
and our building out of our infrastructure, as we've described, will come fairly
proportionately between sales and trading a little bit more
significantly--sales, research, and investment banking. But specifically, our
sales and trading today, actually, if you look at this year so far, it is
actually running at a run rate which is--in fact, north of $150 million
currently.
And so the activity levels are growing significantly, but having said that, we
think there is a direct correlation to our ability to continue to go to
institutional accounts, particularly the top 125 accounts, which we have a very
focused, disciplined effort. Our director of research, the person that leads our
whole institutional equity effort, is going to the 125 largest accounts, and
we're trying to make all of our like-sized clients aware of the depth and the
breadth and the extraordinarily good performance capability of our company, and
in bringing that awareness to them, cause them to recognize that a stronger and
deeper relationship, as measured by commission dollar, is completely
appropriate.
We have had great success, which I think you know, from 2000, when this effort
began. And even though commission spreads have contracted very sharply, our
revenues have grown significantly in this area, and we continue to be very
optimistic that that will continue. In fact, proportionately, if you look at our
secondary commission level, the level relative to our investment banking
business, one might conclude that our secondary trading business should be
multiples higher than it is today.
Now, there are offsets in certain activities as it relates to secondary trading
that we don't do, which will limit that to some degree, but we are optimistic
that proportionality will grow and continue to grow and will grow the sales and
trading line on a very profitable basis as we continue to go forward.
Emanuel Friedman:
As Eric suggested, our model for '04 suggests that both sales and trading will
grow at almost a similar rate as investment banking, both growing a little bit
in excess of 50%.
Richard Herr:
Okay, thank you.
Emanuel Friedman:
We are seeing those trends in the early part of this year.
Richard Herr:
Thank you. And given what your model is and kind of our own estimates, it
appears that the brokers will be generating a significant amount of cash flow in
2004. I know in 2003, in certain quarters, some of that cash flow was lent up to
the REIT in order to, in order to pay the dividend. Any kind of sense of if you
could do that this year as well?
Eric Billings:
Yes, absolutely. That is our express methodology. Specifically, the retained
equity capital in the Taxable REIT Subsidiary, once we retain that capital, we
do lend it up to the REIT so that that capital then can achieve the returns. And
again, as we've stated, historically we believe we can continue to be in that
low 20% level.
This will derive higher earnings and higher dividends to the total company. The
only other alternative, realistically right now, is of course the merchant
banking portfolio. Some part of that will be invested in the merchant banking
area because that opportunity is so significant for us as well.
Emanuel Friedman:
In 2003, the money that went up in the REIT was really used just for investment
purpose. It was not used to pay the dividend, so please keep that in mind for
2003. Our model suggests we will deliver $90 million in after-tax earnings in
2004. The broker-dealer does not require much capital, so we will have excess
capital.
Richard Herr:
So depending on the strength in brokerage earnings, would it be okay to assume
that the $1.79 could maybe be a little bit higher, depending on brokerage
profitability?
Eric Billings:
We really would like you guys to run those models and come to your own
conclusions. We try to provide a model for you based on activity in the company
today and give you the tools to make those further judgments.
But I think what is important is that you can see the dynamic of our corporate
structure, which allows us to have what we believe is significant and dynamic
growth in the Taxable REIT Subsidiary, pay full taxes, retain that equity
capital, lend that equity capital to the REIT, not to pay dividends, but to be
therefore deployed in the spread-based merchant banking side, generating
incremental returns that then can be paid out in the form of dividends, allowing
us to grow not only the earnings vis-a-vis growth in the Taxable REIT
Subsidiary, but also to grow the earnings and the dividends at the REIT part of
the business.
Richard Herr:
All right. Thank you very much, guys. Great quarter.
Facilitator:
Again, if you would like to ask a question at this time, please press "star-one"
on your telephone keypad. [Pause] Your next question comes from Mark Patterson
of NWQ Investments [ph].
Mark Patterson, NWQ Investments:
Hey, guys. Excellent job. A couple of questions for you. What percentage of
equity would you be willing to take the merchant portfolio to - around 24%? And
then in the mortgage-backed securities portfolio, asset-wise, what are you
looking at right now? I'm sorry if I missed that.
Eric Billings:
You mean the yield on assets?
Mark Patterson:
Yeah. Just kind of what product are you looking at on the asset side right now?
Eric Billings:
Specifically, Mark, the first question, as it relates to the percentage, we've
indicated historically that we want to keep the merchant banking in alternate
asset investments, which includes our private partnerships in the vicinity of
30% of capital. It'll bounce around, depending on investment opportunities and
so forth. Clearly, the opportunities that we've indicated are so significant,
and where we think we can achieve very high returns--obviously, on a
risk-adjusted basis, higher than the spread-based business. So we're tending up
toward the upper end of that range and would expect for as long as we believe
these opportunities are available to us. So that's the merchant banking side.
Richard Hendrix:
On the assets, Mark, we actually lowered duration throughout the fourth quarter,
so the mix of the assets today is--or I should say at the end of the year--was
approximately 19% in kind of the 5/1, 4/1 category, and approximately 66% in the
2/1 and 3/1's. As you know, the 4/1's just roll down from original purchases,
and approximately 15% are 1/1's.
Mark Patterson:
Okay, thanks a lot.
Eric Billings:
Thank you, Mark.
Facilitator:
At this time, there are no further questions.
Emanuel Friedman:
Again, thank you very much.
Eric Billings:
Thanks, everybody for joining us.
Facilitator:
Thank you. This concludes your conference. You may now disconnect.
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