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Executives

Philip A. Pendergraft - Chief Executive Officer, Director

Kevin W. McAleer - Chief Financial Officer, Senior Vice President

Analysts

Richard Repetto - Sandler O'Neill & Partners, LP

David Scharf - JMP Securities

Howard Chen - Credit Suisse

Analyst for Kennneth Worthington - JP Morgan

Mike Vinciquerra - BMO Capital Markets

Patrick O'Shaughnessy - Raymond James

Mark Lane - William Blair & Company, LLC

Penson Worldwide Inc. (OTC:PNSN) Q3 2008 Earnings Call October 23, 2008 10:00 AM ET

Operator

Good morning and welcome to the Penson Worldwide Conference Call. Before we begin, I would like to read Penson’s Safe Harbor Statement.

Please note that this presentation contains certain forward-looking statements about management's goals, plans, and expectations, which are subject to various risks and uncertainties outlined in Risk Factors section of Penson's Securities and Exchange Commission filings. Actual results could differ materially from those currently anticipated and we disclaim any obligation to update information disclosed in this call as a result of developments, which occur afterwards.

At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions and comments following the presentation. I would now like to turn the floor over to Mr. Phil Pendergraft, Chief Executive Officer. Mr. Pendergraft, you may begin.

Phillip Pendergraft

Good morning. Thank you for joining us today. I’m here today with Kevin McAleer, our Chief Financial Officer. Kevin and I have a few comments to make about the quarter and then we will be happy to take your questions.

Last night we released our third quarter results. We are very pleased to report that we earned $0.29 per share for the quarter including a $0.06 charge to establish a litigation reserve. Excluding this charge, we earned $0.35 per share from operations that compares favorably with the year-ago quarter when we earned $0.32 per share excluding the Sentinel charge. It should also be noted that least year’s September quarter benefited from a significantly higher average federal funds rate of more than 5% compared to the average rate of 2%this quarter.

Net revenues total more than $79 million; a new quarterly record. And we are up 6% on a sequential basis with non-interest revenues up 7% to a record $58 million and net interest revenue up 4%. Customer net interest revenue increased 4% to $19 million and conduit net interest revenue increased 5% to a record $3.2 million. With the charge, operating earnings were up 26% sequentially to $12 million and margin was 15.2%. Excluding the charge, operating earnings were up 51% to more than $14 million and margin with 18.2%. That compares to 12.8% in the June 2008 quarter and 19.6% in the year-ago quarter excluding Sentinel when interest rates were much higher.

Looking at how the quarter broke out, July’s performance was very strong. August was weak particularly when compared to last year when volumes were higher. September was nearly as strong as July although it was certainly impacted by the market volatility positively, in terms of volume and negatively, in terms of interest revenue. Since September, spread between actual and targeted federal funds widened negatively impacting customer-interest income and stock lending balances were negatively impacted by the two emergency rules related to short selling activity. While the value of our stock lending book increased, the resulting increase in spread did not completely offset the decline in balances.

Overall, we believe the credit market situation had a slight negative impact on earnings in the quarter but not materially so. On the other hand, we believe that what is going on in our industry today is very clearly a validation of our business model. While nobody likes being in the middle of this storm, nobody. We believe that we will ultimately benefit in terms of new customer wins and some competition being weakened or even disappearing.

Now this quarter is a good example of what we have been saying for more than a year since interest rates began falling. In a stable interest rate environment, we can grow the top line at 15% to 25% and the bottom line significantly faster reflecting the operating leverage in our business. This quarter, for the first time in four quarters, we did not have the impact of the decline in rates. And we grew the top line at an annualized rate of 25% and the bottom line at annualized rate of more than 80% even with the charge.

Turning to our revenue lines, clearing and commission fees were up 8% from the June quarter to a record $40 million. This was driven primarily by a 12% increase at PFSI, our US securities clearing business and a 10% increase at Penson’s GHCO, our US futures clearing business. This marks the eighth consecutive quarter where we have set a record for clearing and commission revenues.

In equities, we benefited from strong market volumes in the US, continued growth at our existing correspondents and new correspondents. In auctions, we cleared more than $50 million contracts in the US; up 28% on a sequential quarter basis. September alone exceeded $18 million contracts and our market share was just over 5% in the quarter. And in futures, volumes in the US were strong in July, weak in August and bounced back in September. Penson GHCO benefited from new business and converted a sizable new correspondent that brought meaningful customers, volume and balances right at the end of the quarter. Given the market volatility thus far in October and our continued addition of new correspondent volumes, we believe we will again see record clearing and commission revenues in the fourth quarter.

Turning to technology, revenues were up 21% on a sequential quarter to a record $6.2 million and our Nexa operations were solidly in the black. Recurring revenues were up on both a sequential and year-over-year basis for record levels. This is primarily because our existing clients are growing putting more customers on Nexa’s systems generating more recurring revenue.

Looking ahead, we believe that it is likely that fourth quarter technology revenues will equal or exceed third quarter revenues. But we believe that development revenue will be flat to down slightly from the third quarter. Recurring revenue will likely be at an all time high driven by strong market volumes and customer growth. In addition, revenue from the previously announced licensed transactions will continue at the rate of about $1 million per quarter.

Looking at other revenues, they were level with the second quarter but up 14% year-over-year. The year-over-year growth reflected increased volumes in the addition of our execution services business. Compared to last quarter, negatives from market volatility offset the growth related to volume. We believe that these trends will continue in the fourth quarter so that other revenues will likely be flat on a sequential quarter basis.

Net interest revenue increased to 4% on a sequential quarter basis due to improved results from both customer balances and the conduit stock lending business. In our customer business, net interest revenue increased 4% on a sequential quarter basis to $19 million. Interest earning assets grew by 2%. That reflects strong customer growth partially offset by reduced short balances and a minor reduction in margin borrowing. Even though the average federal funds rate declined 8 basis points from the second to the third quarter, our net interest spread increased 8 basis points to 1.16% due to continued improvements in mix. Conduit net interest revenues increased 5% to $3.2 million. The spread was 57 basis points down from 74 basis points in the second quarter but average balances increased by 38% more than offseting the spread decline making the third quarter our best quarter ever in this business. During the quarter, our conduit book averaged just over $2 billion in balances.

Now, as you know, we have reported a $1.47 billion decline in balance sheet assets since June 30. Virtually this entire decline has come in stock lending balances with our conduit book being the most affected. At September 30, conduit balances were just over $1 billion compared to just under $1.9 billion at June 30. Our in-house balances declined approximately $677 million between these two dates. Now to date, the revenue impact of these declines has been partially offset by an increase in spreads in both the conduit and in-house business. Stock lending inventory has simply become more valuable as the new rules make failing to deliver more costly at least from a customer perspective. As a result, so far in October, our conduit spread has increased to 88 basis points from the 57 basis point average in the third quarter.

Looking ahead, we believe that balances will recover slowly as the industry absorbs and adapts to the new rules. We have already begun to see in-house balances recover although conduit balances remain depressed. Spreads will likely remain significantly higher so that the financial impact of lower balances should lessen steadily as we move towards next year.

Now the end of the third quarter and the first two weeks of October were negatively affected by the unusual credit market condition. If cost of funds and returns on segregated assets swung wildly on many days; these conditions have improved significantly in recent days.

Turning to our interest rate sensitivity, we continue to believe that each 25 basis point cut in the federal funds rate will reduce our net interest income by approximately $750,000 per quarter. Based upon this, we believe that net interest income will be affected by approximately $1.5 million in the fourth quarter due to the fact that the Federal Reserve reduced the federal funds rate by 50 basis points at the beginning of October. Now we estimate that the impact of this decrease in the federal funds rate will lower stock lending balances and the credit market pricing dislocations from earlier this month will reduce overall net interest income by approximately $3 million in the fourth quarter. To say this another way, based upon current rates, we believe that all of these factors combined will result in reduced net interest income of approximately $3 million in the fourth quarter. About half of which will come from the decline in the federal funds rate or associated with our interest rate sensitivity with the balance more contained to just the fourth quarter for the reasons we have discussed.

Now looking at our other operating units, Canada’s net revenue was down 4% on sequential quarter basis off of a very strong second quarter although up nearly 9% versus last year’s third quarter. The acquisition of E*TRADE by the Bank of Nova Scotia was completed on September 22. E*TRADE continues to be a customer of Penson Canada and we now anticipate that they will convert off of our books late in 2009.

And then looking at the fourth quarter, Canada is of to an excellent start. We believe that October volumes will be the strongest in their history. In the UK, net revenues were down 13% sequentially and operating results were in the red for the second quarter in a row. We just simply had a very slow quarter in the UK. The good news here is that we expect to add a total of seven new correspondents between the third and fourth quarters. Thus if these new correspondents come on-line, we anticipate an improvement in revenues in the fourth quarter and a return to profitability by the end of the year.

The Penson GHCO futures business was meaningfully stronger in the third quarter as compared to the second quarter. Net revenue was up 16% on a sequential basis. Segregated funds ended at $460 million compared to $436 million at the end of last quarter. And average balances for the quarter were $400 million compared to $350 million in the third quarter. Consequently, interest income was meaningfully higher which benefited our overall mix. We achieved this increase despite the significant decline in overall commodity price levels in the third quarter which reduced exchange margin requirements and had a corresponding negative impact on SEG funds requirements and the large decline in overall open interest in commodity contracts.

At the end of the third quarter, we converted AlloOne trading from a CME clearing member to an omnibus relationship on our books. This new customer should have a positive impact on our fourth quarter results. While our interest earnings at Penson GHCO will be negatively impacted by the recent rate cuts in credit market dislocations, volumes remain high and we anticipate another strong performance in the fourth quarter.

As for new business, we had another strong quarter in that area companywide. We added a net of 5 new revenue generating correspondents for a total of 300. Securities clearing operations added two net new correspondents and Penson GHCO added three new introducing brokerage firms. We actually added a total of nineteen new firms and lost or terminated 14 mainly due to consolidation or closure. The losses did not have a material impact on revenue while many of the wins are already contributing. Not reflected in our third quarter correspondent count is our pipeline which totals 29 new securities correspondents. They are likely to begin contributing to revenue in the fourth quarter or the first quarter of next year. Twenty one of them were signed during the third quarter and eight are from prior periods. I am also pleased to announce that we have reached an agreement in principle with our largest correspondent, Thinkorswim for a two year contract extension which will take us through end of 2010.

Now let us turn the call over to Kevin for a few comments.

Kevin W. McAleer

Thank you Phil. Good morning everyone. Operationally, this was a challenging quarter due to the volatility in pricing and in volumes. We made a number of changes to our software and workflow processes and upgraded hardware. As a result, we are probably in the best shape that we have ever been in from a capacity perspective. Partly as a result non-interest revenue per day hit a record $908,000 up 8% from a record in the second quarter.

Looking at operating expenses, year-over-year, non interest revenues grew by 30%. We obtained nice operating leverage on compensation which was up only 10%, floor brokerage up 21% and communications and data processing up 26%. Occupancy was up 29% year-over-year mainly due to the higher depreciation expense incurred as a result of prior additions to our capital.

When I look at this sequential compensational expense, it decreased 4.3% this is primarily due to tax benefits for lower employment cost in Quebec, lower staff compensation due to employee turnover and lower performance based compensation. I will get to the other expenses in just a minute. In the absence of the impact of the 61% decline in the average federal funds rate year-over-year, our operating margins would have been 25%.

Other expense is up primarily due to the Samco litigation charge. Over the past three years, Samco Financial Services, one of the businesses pulled off Penson at that time of our IPO in 2006 and certain of its principals and Penson Financial Services and certain of its directors have been named in a number of claims related to activities at Samco Financial Services. Claims against Penson and its directors were covered by indemnity and by insurance. The majority of these claims have been resolved without any expense to Penson. And so recently, we have believed that the indemnity will be sufficient to cover all outstanding claims. I now believe that this will not be the case. Samco Holdings and certain of its affiliates, in exchange for our release of certain indemnity claims, have agreed to a settlement fixing the amount of their indemnification obligation to Penson with respect to these matters and Roger Engemoen, our chairman who is also affiliated with Samco has agreed to guarantee certain of Samco’s required payments.

The litigation reserve reflects our current estimate of liability that we expect to incur with respect to these matters through their conclusion, after the remaining indemnification contributions from Samco.

Looking at our share count, primary reason for the 2% increase in shares from the second to third quarter is the accrual for the performance related payments that will be due to the Samco acquisition. As with regards to the acquisitions itself, we continue to have many conversations but nothing conclusive. Sooner than to what we said last quarter, given the price of the stock, the hurdles are high as we do not want to use our shares at this time as part of acquisition package.

And now, here is Phil to wrap it up.

Phillip Pendergraft

Let me try to pull everything together for you because the fourth quarter has a lot of moving parts. We insist to pay strong non-interest revenues especially in clearing and commissions. This should be driven by strong market volumes and by continued growth in market share especially in futures and options. It will also be helped by the continued addition of new correspondents and the growth of existing ones.

We also expect to be positively impacted by improvements in the UK and believe that Nexa will remain in the black, marking its third consecutive quarter or profitability. The fourth quarter, however, will be negatively impacted by the lower federal funds rate, by softer stock lending revenues and by the dislocation in the credit markets that we have seen. Typically, we would expect to see an uptake in earnings between the third and fourth quarter, as a result of year-in cost reductions, rebates and other seasonal factors. While it is still early, due to the factors I have mentioned, we believe that it is more likely that fourth quarter revenues and earnings per share will be flat on a sequential quarter basis with our gap results for the third quarter.

Looking into next year, we have certainly heard the talk about retail investors leaving the market after the kind of volatility and uncertainty we have seen. While this could happen, the impact on us would be muted by our broad product diversification and by our active trader customer base. The clients of our largest and most important correspondents are attracted by volatility not repelled. This is part of what has driven our 30% non-interest revenue growth over the past year. Our interest rate exposure continues to fall if non-interest revenues become a proportionately larger part of the business. Third quarter non-interest revenues were 73% of total net revenues versus 65% a year ago. Our correspondents are continuing to grow and we are continuing to add new correspondent relationships and to upgrade our list of existing correspondents.

Our pipeline of signed but not yet producing correspondent relationships is at an all time high. We believe that this quarter’s performance validates our ability to hit our 15% to 25% revenue growth targets and our ability to grow earnings at a faster rate. We believe that once past the unusual challenges of this quarter, we will begin to grow revenues and earnings again as we move into next year.

So, despite the uncertainties in the market place and in some cases because of them, we continue to be optimistic about the strength of our competitive position and our ability to grow our businesses.

We appreciate your support and confidence and interest in the company. With that, we would be pleased to open the call up for questions and answers.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of MikeVinciquerra of BMO Capital Markets. Please proceed.

Mike Vinciquerra – BMO Capital Markets

Good morning Kevin. A couple of things, I just want to make it crystal clear. You guys have 300 clients a day that are producing revenue and 29 that are signed but not producing revenue. Was that right?

Kevin W. McAleer

That is correct.

Mike Vinciquerra – BMO Capital Markets

Can you give us any color, you mentioned on the 14 clients that you lost and they were due to mergers and closures, were there any important clients in there? Is 14 a typically high number for you guys in terms of losses in a particular period?

Kevin W. McAleer

You know it is and I want to be clear, they did not all close or consolidate; I think we lost three to competitors. You know frankly in times like this, we are looking very closely at our customer list, obviously these are challenging times and so we are watching our list pretty carefully and I would not expect that that trend will continue, I think that this is an unusually high quarter.

Mike Vinciquerra – BMO Capital Markets

Okay and of the clients you signed, two questions there: One, can you compare their quality, I guess, to the average, revenue production of your average correspondent in terms of potential and then I will come back for my second question.

Kevin W. McAleer

Okay so, the clients in the pipeline, the 29, I think generally speaking are going to be at or above our current average. You know, we are not signing, we are signing fewer small correspondents but I would not say that of the 29 in the pipeline, we necessarily have any potential, but you never know, we could certainly have some homeruns in there but nothing that I could point to right now and say this will be a homerun. We do believe, however, that as some of the previously announced firms, like Scottrade and Monex or Van der Moolen as they come fully onto line, that those will be much better than average clients.

Mike Vinciquerra - BMO Capital Markets

Okay and then a follow on to that is: are you taking more of these new accounts from, from competitors or are you getting a fair number of startups and new operations, I think, Scottrade is an entirely new business for them if I am not mistaken.

Kevin W. McAleer

Yes it is. I would say that in the, that over the last quarter, we have had some good success at winning business from our competition. You know our business model really is resonating in this market place. So we have won business from a number of competitors. Those 29 firms most of them came from competitors.

Mike Vinciquerra – BMO Capital Markets

Got it. Okay, I will jump back in queue. Okay. Thank you.

Kevin W. McAleer

Thank you.

Operator

Our next question comes from the line of Richard Repetto – Sandler O'Neill. Please proceed.

Richard Repetto – Sandler O'Neill & Partners, LP

Good morning Phil and Kevin.

Phillip Pendergraft

Rick,it is good to talk to you sir.

Kevin McAleer

Good morning Rick

Richard Repetto – Sandler O'Neill & Partners, LP

I guess the first question is on the comp, you know, you did see a very sharp reduction sequentially and you gave us the reasons why. I am just trying to see, you know, what is sustainable there and what the one time shot is.

Phillip Pendergraft

Rich I think that you could certainly expect compensation expense will be up in the fourth quarter but a reasonable portion of the decline was related to production-based compensation or stock-based compensation and, if those are hard, the stock-based compensation decline is permanent but the performance based will be based upon how those particular businesses do in the fourth quarter.

Richard Repetto – Sandler O'Neill & Partners, LP

Okay. Could you just quantify, ballpark, what the stock-based comp is declined that will not be in their exempt?

Phillip Pendergraft

Yes it is the smallest of the three, I do not actually have the number but it, perhaps we can come back to you on that?

Richard Repetto – Sandler O'Neill & Partners, LP

Okay, and then the next question is, we are getting good feedback that marginal loan balances are declining dramatically whether, I am not fully certain why whether we are getting sold out of positions or closing position one. But are you saying that and is that factored and is that what you are considering in the credit issue in regards to the interest income and steep decline in margin balances?

Phillip Pendergraft

You know, Rich, we have not seen that kind of fall off in margin balances. When I talk about the credit dislocation I am talking more about really some pricing anomalies that we saw over the last couple of weeks of September and the first couple of weeks of October, more around an actual and targeted fed funds rate. Our margin balances I think are down 5% from the peak this summer. That is all.

Richard Repetto – Sandler O'Neill & Partners, LP

Well, just FYI, Ameritrade had seen this down at 3rd in October alone from the end of September.

Kevin W. McAleer

But we have not seen that-

Phillip Pendergraft

Primarily the decrease was in our conduit of the $1.2 million.

Richard Repetto – Sandler O'Neill & Partners, LP

Okay, and I guess the last question. You gave us some solid guidance in regards to the fourth quarter, I guess this is a two part question, is what volume assumption do you make because obviously you expect querying and your commissions to increase; what volume assumption were imbedded there, and then sort of what do you see say in 2009 I know that is not one easy task that you can crystallize right now.

Phillip Pendergraft

I think you guys are the ones with the crystal ball.

Richard Repetto – Sandler O'Neill & Partners, LP

Mine is a little cloudy right now.

Phillip Pendergraft

You know we are basing our fourth quarter assessment on the trends we have seen over the last sixth or eighth weeks. We have had since the end of August. We have seen very strong growth in transaction volume. We actually hit it here in the United States. We have one day where we hit 6.2 million executions, which is an all time record for us. And we have seen really strong volume in Canada as well. With almost one month under our belt, we are comparing very favorably to the third quarter in that area. Now, as I look at next year, obviously it is harder to forecast. We think we are going to continue to grow. I think you and I have had this conversation before, but we think that because of the number of the regulatory changes over the last two or three years and we are in a secular bulk market for volumes. Now, they may not grow the way that they have grown over the last two months. We have sort of seen very strong growth the last couple of months. But we think we are going to continue to grow over all in the market place because of some of these secular changes and obviously we got 29 new correspondents sitting in the wings and so even if volume growth mutes in the overall marketplace, we are going to be piling on more customers.

Richard Repetto – Sandler O'Neill & Partners, LP

I understood, that is what I was looking for in the outlook. Thank you.

Phillip Pendergraft

You are welcome.

Operator

(Operator instructions)

Our next question comes from the line of David Scharf of JMP Securities. Please proceed.

David Scharf - JMP Securities

Thanks. A question on competition, you had remarked in the beginning of your presentation that this environment is actually becoming more attractive from the stand point of competitors weakening and so forth. Can you give a little more specific color on that? I mean, are you noticing anything in particular of some of the top tier clearing firms that suggest the rate of your competitive take-away should accelerate over the next 24 months.

Phillip Pendergraft

We certainly, are seeing much more interest in the non-conflicted exchange lifted kind of model that we have. Compared with some of the bigger firms that do so many different things, some of which have actually brought some really unanticipated risks to their business. And so, I would not necessarily say that those firms have been weakened financially, particularly since the government seems to be providing backstopping for most of them. But I think their business models had become less attractive to the correspondent marketplace. And so we are definitely seeing more interest from, I mean- we are having more success in marketing to firms that clear at some of our larger competitors. When I say larger I mean, in terms of size not necessarily in terms of the correspondent business because obviously we are pretty big in that.

David Scharf - JMP Securities

I got you. Switching to the pipeline, I just want to make sure I heard it correctly. Of the 29 signed by the actively converted correspondents in your pipeline, you had said that, on average, they are larger than your current average client right now that you are clearing for?

Phillip Pendergraft

Yes we believe that to be correct based on our analysis of the business.

David Scharf - JMP Securities

Okay, so just very, very simple math, I mean would that suggest that if these were all converted by year end, we are potentially talking about, on a combined basis; given you have an installed basis or 300 on a combined basis. We are talking about a 10% increase in volumes holding everything else constant obviously.

Phillip Pendergraft

Yes, I think that is accurate although, they would not all be converted by year end, it will be unlikely; they will all be converted by year end.

David Scharf - JMP Securities

No, No, No, that is understood. I just want to make sure we have a correct read on the order of magnitude. Okay. And I know the question was answered a few times in terms of compensation and it sounds like well, I obviously see a little bit of a tick off in the fourth quarter but, I just want to get a sense for whether or not you see any step functions in that line item going forward or the roughly 30 million a quarter, a pretty decent number to fix on for the next 12 months.

Phillip Pendergraft

I do not see any step functions in that line item. Obviously, an acquisition would change it but in our current businesses, based upon what I know today, I know I think that I do not see any real step function. We are getting, obviously, some operating leverage as we add new customers without having had to add people or staff. We would expect to grow employment next year because we expect to grow the business base but we certainly would expect it to grow slower than the revenue base.

David Scharf - JMP Securities

I got you. And lastly, on the 14 vast firms it sounds like about half of those were correspondents that have actually closed down during the quarter?

Phillip Pendergraft

Yes, closed or were consolidated.

David Scharf - JMP Securities

Any even looking into the first 3 weeks of October are you seeing any trend in terms of an acceleration of that? Over the last couple of months obviously everybody has got an eye on the health of the retail investor and is there anything you can conclude based on the trends over the last 6 weeks that somebody’s firms shutting down or is this just regular order of business. Is it going to be variable from quarter to quarter?

Phillip Pendergraft

It is going to be variable. We are not seeing any real trends. We have not had any, I mean but we certainly have correspondents that took losses in the last 4 to 6 weeks. We have not had anything; we have not anybody go under because of the loss they took related to volatility. At least at this point, our correspondents seem to be weathering the storm pretty well.

David Scharf - JMP Securities

Okay, and then the last question just regarding those spreads on the conduit business. It sounds like, did I hear you correctly, and you feel fairly comfortable that the new regulations regarding delivery for short selling could pretty much increase the secular profitability of that business and you pointed to a pretty significant expansion of that spread on the fourth quarter. Is that a sustainable level? I think you said was it 88 bases point?

Phillip Pendergraft

Yes. Actually, I think yesterday it might have been over a 100 basis points, which is the highest I think we have ever had. At this point in time, it is hard for me to say what the overall impact of the rule changes are going to have on conduit business, because I do not know what balances are going to do. So, balances are certainly down probably 50% on a quarter ending vs. quarter ending basis. But spreads are up and so if we are unable to increase balances from here then the overall profit margin will be higher but the revenue dollars will be less because it will be on a lower base.

David Scharf - JMP Securities

Right, right but recognizing those balances is going to recover but I just want to get a sense if you feel that the higher spread is reflective of the secular change in the requirements of maintenance delivery and so forth.

Phillip Pendergraft

Yes, yes understood. I understand the question. We do believe balances will recover slowly and we do believe the spread is going to stay high.

David Scharf - JMP Securities

I got you. Thanks so much.

Operator

Your next question comes from Howard Chen from Credit Suisse. Please proceed.

Howard Chen - Credit Suisse

Good morning Phil Good Morning Kevin. Phil, you spoke of recurring Nexa revenues being at record levels during the quarter. How much was that recurring vs. development breakdown this quarter?

Phillip Pendergraft

We will get that for you. Do you have a second question?

Howard Chen - Credit Suisse

I do. And a third.

Phillip Pendergraft

I will get you the answer.

Howard Chen - Credit Suisse

Great! You continue to install a lot of new business and your customers are typically in a growth mode so it is hard to see what impact if any, equity market fluctuations have on the customer franchise. If you look at existing customers that have been with you for sometime can you see a material impact on balances just simply from market appreciation or depreciation?

Phillip Pendergraft

We have not looked at that specifically. We have looked more on overall balances which have been other than the stock lending area have been relatively stable.

Howard Chen - Credit Suisse

Okay and in just---

Phillip Pendergraft

And the answer to your previous question is that our recurring revenue in the quarter was 53% total revenue.

Howard Chen - Credit Suisse

Okay excellent. Thanks. And just to clarify your commentary of thinking about a $3 million sequential quarter step-down in net interest income, that assumes no change in customer margin lending balances during the fourth quarter from the third. I know that is just a snapshot of one moment in time but I just want to make sure, I am clear on that.

Phillip Pendergraft

Yes. We were down about 5% from our peak. And so we are basing it on those on our current levels but we are not assuming a step-down. We have not seen it.

Howard Chen - Credit Suisse

Okay and then finally, with regards to Samco what is the current business relationship between Samco and Penson and how much revenue do you generate from the relationship and what services are you all providing for them.

Phillip Pendergraft

Well, there are a number of Samco Companies and the largest Samco Company we clear for and we will continue to clear for probably generates a million dollars in revenue. And that company is in fine financial shape. The charge that we are taking here is related to activity at another broker dealer that Samco owned and we believe we have now recorded, with these charge, what would be a full exposure, expected exposure to settle this outstanding clients.

Howard Chen - Credit Suisse

Okay. Thank you so much.

Operator

Our next question comes from the line of Ken Worthington of JP Morgan. Please proceed.

Analyst for Kennneth Worthington – JP Morgan

Hi this is Tim sitting in for Ken.

Phillip Pendergraft

Hi Tim.

Analyst for Kennneth Worthington – JP Morgan

Sorry I will bring you to the pipeline again. But we were wondering you if we could just get a breakout of the 29 accounts in the pipeline by geography and customer type.

Phillip Pendergraft

Well I can give you geography, now. I do not really have customer type as a method for your metric but the geography is 22 in the US, 4 in Canada, 3 in the UK, for 29.

Analyst for Kennneth Worthington – JP Morgan

Okay and then the only other thing is with cuts, is with fed rate cuts if we were to see another 50 to 75 basis points of cuts by year end, would the same 750 per 25 formula hold or is there a point where we get low enough to that impact increases.

Phillip Pendergraft

We think the 750 is a good number.

Analyst for Kennneth Worthington – JP Morgan

Okay that is it for us then. Thank you.

Phillip Pendergraft

Thank you.

Operator

Our next question comes from the line of Patrick O'Shaughnessy with Raymond James.

Please proceed.

Patrick O'Shaughnessy - Raymond James

Hey good morning guys. A question about your customers, have you seen any difference in how certain customer groups are performing or trading in September and end of October and others. So for example have you seen some of your customers that are more retail oriented fall off a little bit more and maybe some of your professional trading groups are trading more, have you seen any bifurcation like that?

Phil Pendergraft

No not really.

Patrick O'Shaughnessy - Raymond James

Does everybody across the board seem to be trading elevated levels along with the volatility?

Phil Pendergraft

Yes. Although, I do, did want to point out, we are seeing particularly strong activity in the derivative space Options and futures customers have been particularly active. It appears that we are going to go over 20 million option contracts in October which will be a 10% increase from September.

Patrick O'Shaughnessy - Raymond James

My next question ahead was that you have $320,000 charge for vendor related impairment. Is that going back to setting on this kind of tied up with things there?

Phil Pendergraft

That is essentially legal cost associated with Sentinel.

Patrick O'Shaughnessy - Raymond James

I got it. So we should not expect anything else on that light going forward from here.

Phil Pendergraft

We do not anticipated any further charges beyond legal expenses related to that but as you know, Sentinel is still in bankruptcy and there is a number of litigation items outstanding related to Sentinel. We have recorded everything we believe that we need to record related to that based upon the current set of facts.

Patrick O'Shaughnessy - Raymond James

And there is potential you could have some sort of recovery which would actually be on the positive for you.

Phil Pendergraft

Again, there certainly is a potential, there. We are not holding our breath. We have discovered after having been this close to the bankruptcy process. We have sort of discovered that really the only people who had made money on that are lawyers.

Patrick O'Shaughnessy - Raymond James

Yes, sounds about right. Next question I had was, have you guys seen an increase in your bad debt expense given all the volatility taking place? Have the customers pretty much made good on all the marginal loans that you are extending to them?

Phillip Pendergraft

Yes. We have not taken any meaningful any margin losses. I think some of our correspondents had taken some losses but nothing that has impacted viability. Now, and I think that is a tribute to our people and our systems. Systems are working the way they are designed and people are working extraordinarily hard. But I do not want to appear blasé, this is an extraordinarily difficult time, given the massive volatility even on an inter day basis. So, we have had good experience thus far, because we have good people and good technology and we believe that it is going to continue to protect us but I will not say that I am not waking up in the middle of the night worrying about things.

Patrick O'Shaughnessy - Raymond James

Are you saying that the big foot seventy keeps you on your toes?

Phillip Pendergraft

The big foot seventy keeps me up at night.

Patrick O'Shaughnessy - Raymond James

Last question I have was, looking at your balance sheet the corporate cash fell from 130 million to 70 million. Now, if I recall correctly you had a cash payment to Shaunfeld in July, I remember. I was wondering if you could kind of walk me through the rest of the drop there.

Phillip Pendergraft

Patrick I cannot, we will have to look at that. It is a function of cash flow between our working capital financing with our banks, it not particularly meaningful.

Patrick O'Shaughnessy - Raymond James

I got it. Great, thank you very much.

Phillip Pendergraft

Yes sir, thank you.

Operator

Our final question comes from the line of Mark Lane of William Blaire and Company. Please proceed.

Mark Lane – William Blair & Company, LLC

Good morning. Can you give us the quarter ending interest earning balances, and liabilities, the total number?

Phillip Pendergraft

The quarter ending. Mark, I do not have that number handy I would be happy to come back to you on it. You know the major difference between average and quarter ending is the 1.47 billion decline in the stock lending book if not in other customer balance sheet.

Mark Lane – William Blair & Company, LLC

Those are presumably up. Correct?

Phillip Pendergraft

They are up slightly but I think our overall decline is a little bit less than 1.47 on a period to period to basis.

Mark Lane – William Blair & Company, LLC

On a period to perioD?

Phillip Pendergraft

Yes I believe others are up slightly.

Mark Lane – William Blair & Company, LLC

Okay and can you just clarify in response to Rich Repetto’s question regarding within your prepared remarks about credit dislocation and the pricing anomalies that are exactly what you are talking about, and is that still occurring.

Phillip Pendergraft

No, we see dramatic improvements there but essentially what we are saying is that normally, pricing on both the investment and borrowing side is based upon set funds and it is pretty stable but over the last 4 weeks we have seen those things bounce around a lot and so there have been days when we have earned less than we anticipated on our segregated balances and paid more than we would have anticipated on financing.

And it has just been a function of how crazy the credit markets have been. That is really the macro policy decisions that have been made here in the United States and globally really that had begun to have an impact in the credit market, have really largely resolved those issues.

Mark Lane – William Blair & Company, LLC

Just to clarify, a move from 200 basis points to 175 basis points is a same earning sensitivity as moving from 125 to 100, is it the same or it is just not materially different?

Phillip Pendergraft

It is not materially different. I mean it is not dollar for dollar exactly the same but it is not materially different.

Mark Lane – William Blair & Company, LLC

Okay, I appreciate it, thank you.

Phillip Pendergraft

Yes sir.

Operator

I would now like to turn the call over to Mr. Phil Pendergraft.

Phillip Pendergraft

So, I think we have now set a record for the longest earnings call in Penson history. Thank you all for your questions and for your participation today. We really appreciate your joining us and we appreciate your interest in Penson. We look forward to chatting with you again when we report fourth quarter and year-end results in February. On behalf of all the Penson team around the world, we would like to wish you all a very good day. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation, you may now disconnect. Good day.

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Source: Penson Worldwide Inc. Q3 2008 Earnings Call Transcript
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