MF Global Ltd. F2Q09 (Qtr End 9/30/08) Earnings Call Transcript

Nov. 5.08 | About: MF Global (MFGLQ)

MF Global Ltd. (MF) F2Q09 Earnings Call November 5, 2008 8:00 AM ET

Executives

Jeremy Skule – Vice President, Investor Relations

Bernard W. Dan – Chief Executive Officer

Randy MacDonald – Chief Financial Officer

Analysts

Roger Freeman - Barclays Capital

Kenneth Worthington - J.P. Morgan

Christopher Allen - Banc of America Securities

Michael Vinciquerra - BMO Capital Markets

Richard Repetto - Sandler O'Neill & Partners L.P.

Robert Rutschow - Deutsche Bank Securities

Jonathan Casteleyn - Wachovia Capital Markets, LLC

Operator

Good day, ladies and gentlemen, and welcome to MF Global's second quarter 2009 earnings conference call. My name is [Regina] and I will be your conference coordinator for today. (Operator Instructions)

I will now turn the presentation over to your host for today's call, Jeremy Skule, Vice President of Investor Relations. Please proceed.

Jeremy Skule

Good morning and thank you for joining MF Global's second quarter 2009 earnings call. With us today are Bernie Dan, MF Global's CEO, and Randy MacDonald, our CFO.

This conference call is being recorded on behalf of MF Global and consists of copyrighted material. It may not be recorded, reproduced, retransmitted, rebroadcast, downloaded or otherwise used without MF Global's express written permission.

The information made available in this conference call contains certain forward-looking statements that reflect MF Global's view of future events and financial performance as of September 30, 2008. Any such forward-looking statements are subject to risks and uncertainties indicated from time to time in the company's SEC filings. Therefore the company's future results of operations could differ materially from historical results or current expectations, as more formally discussed in our SEC filings. The company does not undertake any obligation to update publicly any forward-looking statements.

The information made available also includes certain non-GAAP financial measures as defined under SEC rules. The reconciliation of these measures is included in the company's earnings release, which can be found on our website and in the company's current Form 8-K furnished to the SEC in advance of this call.

With that, I'll now turn it over to Bernie.

Bernard W. Dan

Thank you, Jeremy. Good morning, everyone. I appreciate your interest in MF Global.

I'd like to start with an overview of the quarter, share some comments on current market dynamics, and then discuss the impact on our business. Randy will then provide some details on our financial performance and then prior to questions I will talk about some near-term priorities.

On Page 3 of the presentation we highlight some of the key quarterly performance metrics. In light of broader market conditions, these results are favorable and further highlight the benefits of our diversified model.

Our Metals business is a good example of our product, customer and geographic diversity. Many of the base metals, such as aluminum, copper, lead and nickel, experienced higher levels of volatility this quarter. Additionally, activity in China was strong, as many of the corporate hedgers were actively addressing global price movements. New accounts, as well as organic growth amongst existing clients, particularly our CTA customers, contributed to this favorable result.

Further, our U.S. Fixed Income team continues to perform well, and its expertise was recognized in the quarter. The Fixed Income Clearing Corporation Division of the DTCC sought guidance from our U.S. fixed income team on the unwinding of the Lehman Brothers U.S. Treasury and agency repo book. After the completion of the liquidation of the underlying securities, we were selected to manage and maintain the residual cash flow of the matched book. We view this as a great opportunity to enhance our reputation and create value for our shareholders.

So what we delivered this quarter was strong performance consistent with our balanced market model. While our volumes were down, certain principal transaction-based businesses were strong, such as Metals and Fixed Income, coupled with consistent performance from many of our cleared businesses, such as Retail and Private Clients, which contributed to delivering the same top line results as last quarter.

Our EBITDA remains strong at $66 million and provides a sizeable cushion versus our debt covenants.

Our adjusted earnings per share, absent two nonrecurring charges and the dilutive effects of our financing, would have been on par with last quarter's adjusted earnings per share.

So in summary, this past period was unprecedented in terms of volatility and risk. With volumes down quarter-on-quarter, net interest income up, and matched principal business remaining stable, MF Global delivered solid revenues, strong cash flows, and strong earnings per share.

On Page 4, again, you can see the balance of our model as we actively manage the business to capture opportunities on the transaction side as well as the interest income. As important, this slide highlights the opportunity we have to further diversify our revenues by focusing future efforts on the development of fee-based revenues. By building fee-based revenue sources, the company will further diversify revenues, which predominantly now are driven by volumes and spreads, which should in turn enhance the consistency of our earnings performance.

The chart on the left shows that our quarterly performance was also impacted by a significant drop in industrywide volumes in August. In fact, August was one of our slowest months ever and volumes were down significantly from one year ago. This chart also highlights the diversity and resiliency of our model as we clearly benefited from increased volatility and, as such, we realized significant improvement in volumes and revenues in September.

As we move to the chart on the right side of the page, our investment team took proactive steps to position the company to benefit from increasing spreads between fed funds and 30 or 90-day T bills. We were able to take advantage of this widening in September to help offset lower client payables in the quarter. Both the volatility in volumes and the widening of the spreads were unique to this period and are not something we would view as sustainable over the long term. However, we continue to actively identify and manage these revenue streams so that we are in the best position to take advantage of opportunities.

Turning to Slide 5, we have expanded our client base by more than 30% over the last two quarters. These new accounts have not necessarily correlated to increased client payables. Rather, they have contributed to net new revenues and volumes. The decline in customer payables this quarter is largely due to clients sweeping excess funds from their accounts, a trend that we have seen throughout the industry.

Our mix of client payables through the second quarter remains well balanced, with retail balances at approximately $3 to $4 billion and institutional assets at roughly $9 to $10 billion. And as we've said in the past and this chart illustrates, we don't see any absolute correlation between client payables and volumes.

Since my appointment as CEO, I have met, spoken with and received feedback from a large number of our clients and shareholders as well as most of our key producers, senior staff, as well as many employees around the company. My primary focus has been to ensure a seamless transition and focus on MF Global's competitive position and key short-term goals that deliver results for our clients, shareholders and employees.

From my conversations over the past week, it is obvious that our key producers and staff around the globe are all aligned and working toward a common goal of delivering value to our customers. As we provide our staff with the vision, tools and support to serve their customers better, the end results will be increased value for our shareholders.

Turning to Page 6, as mentioned previously we have focused on balancing risk and reward in today's volatile environment. It is important to note that we are in the risk management business. Our philosophy is to take measured risks and mitigate unexpected risks. Since I joined the company, we have worked to improve the historically strong and effective risk systems and procedures, so our goal is to not only strengthen our overall governance model - including the management structure of the company - but also to enhance the total efficiency of this organization.

This quarter experienced some of the most volatile market conditions ever, with the VIX rising above 80. As we said last week, we are focused on growth, but not at the expense of adding to our risk profile. So while MF Global's execution and clearing volumes were down 7% year-over-year, slightly underperforming the exchange composite this quarter, our risk management was solid. Looking at the right half of this page, you can see that over the last six months errors and bad debts were 2% of net revenues, with the bad debt portion entirely related to the bankruptcy of Lehman Brothers.

There has been a concerted effort to continuously improve our risk management systems and procedures as well as enhance our overall governance model. Michael Roseman, our new Chief Risk Officer, and his team have done a great job. Leveraging the early work of our external risk consultants, they've increased staffing levels to ensure seamless global interaction and communication, they've improved systems and procedures to enhance risk oversight, and where appropriate they introduced increased collateral and entered margin calls to mitigate risk.

These efforts under a general theme of repricing or reevaluating risk have enabled us to effectively manage risk in these turbulent and unprecedented times. Our longer-term work to continuously improve our governance model and our enterprise-wide risk management culture will help to contribute to the strong financial performance of the company.

Turning to Slide 7, I want to share with you some of the feedback I received from our clients over the past weeks and months. While many of our clients have been managing the volatility over the last two months, they have also clearly indicated their preference for an independent company to serve as their intermediary.

What gives them confidence in our model is the global scale we have to generate strong cash flows, along with the fact that we are primarily an agency only intermediary and generally conflict free. They understand that our value proposition is centered on providing the best execution and clearance services in the market.

Our customers view MF Global as a preferred alternative to large government-backed institutions with significant proprietary trading desks as well as smaller competitors that lack the necessary scale and distribution to effectively compete in the global marketplace. Their reasons are as follows: MF Global offers an independent, generally conflict-free model. We don't compete with our clients. The company has unmatched diversity across products, markets and geographic regions. As the chart here indicates, there isn't a single company amongst our peer group that offers the range of products that we do.

Going forward the key to leveraging this strong position is to more effectively integrate our global distribution, organizational structure and knowledge base to produce an even more compelling value proposition to the market.

And perhaps most evident in today's market environment, we have a resilient business model. This company has a strong history of 225 years in the brokerage business and has weathered all types of market conditions and risk scenarios. In particular, over the last two years the company has navigated difficulties and has been through an enormous amount of change.

The fact that MF Global remains the market leader, generating significant cash flows and focused primarily on continuously improving its governance and risk processes, speaks volumes about the character and integrity of our employees around the world. They have much to be proud of as we focus squarely on the future.

With that, I'd like to turn the call over to Randy. Randy?

Randy MacDonald

Thanks, Bernie. Let's start with Slide 8, which is an EPS roll forward. And in the following slides what I'll do is I'll go through with you the details of our income statement and the balance sheet, and then I'll give you an update on our capital structure and liquidity.

But the first thing I want to do is ground you in the results for this quarter. In the June quarter we reported $0.29 of non-GAAP EPS versus $0.14 in the current quarter, and there were four things that accounted for this difference - the higher interest expense and dilution from the new capital structure, the severance costs, the Lehman Brothers bad debt, and then a more normal tax rate this quarter than in the June quarter. Then, if you exclude the severance costs of $0.05 and the Lehman Brothers bad debts of $0.02, that gets you to adjusted non-GAAP EPS of $0.21.

However, let's look at this in a much more detailed fashion. Let's turn to Slide 9, the key financial metrics.

Now what we've done here is we've lined up the September quarter versus the sequential or the June quarter versus the same quarter last year for certain of these key financial metrics. Now I'll discuss the net revenues in some detail on the following slides, so the only thing I want to note here about the net revenues is that that same quarter last year was our second-best quarter.

Now to make this slide easier to compare, we've removed the effects of the Lehman bad debt of $8 million and the related compensation savings and the $11 million in severance costs. Now looking at the compensation expense as a percentage of net revenues, it's basically unchanged, about 55%. Now we expect further severance expenses of approximately $13 to $14 million in the coming quarter, including our former CEO's severance.

Now we'd expect any of those savings from these efforts to be deployed toward growth opportunities in the business. In many cases, the severance that was paid to producers, they were paid to producers not making the appropriate contribution to the producing team, but the team is still earning the compensation pool, or what we've done is we've simply replaced skill sets. So we expect to see increased efficiencies but not absolute savings in the compensation run rate.

Now, turning to the non-comp expenses and then comparing that to the June quarter, excluding the Lehman bad debt we were flat. However, I'll note that the June quarter included a $4 million foreign exchange gain, so we actually saw an improvement this quarter. Comparing it year-over-year, the adjusted non-comp expenses increased $4 million and that was primarily from increased occupancy and equipment due to new space in London and New York and increased communications and technology due to investment in our systems and licenses.

Interest expense on borrowings was higher this quarter than in June and that's directly related to our recent recapitalization. The amount of the debt outstanding was lower, but the rate on the debt was higher. Now the inverse is true when you compare the June quarter to September of last year. The debt structure was the same, but the rates were significantly lower.

Now year-over-year pre-tax margins were mostly impacted by reduced revenues net of the related compensation expense, but also a change in the mix of those revenues, particularly the lower interest income from client payables, which has little associated expenses. Now very little of the change, either sequentially or year-over-year, was due to changes in the noncomp expense or interest expense.

The effective tax rate, that moved back up to 31%, which was actually slightly better than what we expected. Between the mix of business and some state tax credits, the June quarter was lower than the expected effective tax rate for the year of 31%.

And then EBITDA decreased $15 million from the June quarter, but was still quite healthy. And it gives us approximately one-quarter's amount of EBITDA as a cushion against our debt covenants.

So let's now drill down on the net revenues and let's turn to Slide 10. It's entitled Second Fiscal Quarter 2009 Net Revenue. Now hopefully many of you remember this slide from our previous call. People told us it's pretty helpful, so we'll continue to produce and refine it.

There are two things that are different from last time. The first is we discovered the need to correct some historical execution-only volumes, so in the Appendix we've provided you with the historical adjustments for this yield. In reporting our volumes to us, our service provider mistakenly included [break in audio]. Now for comparison purposes, you may want to refer to the next slide, which is Number 11, and that shows you the same information for the first fiscal quarter of 2009.

Now I plan to go through this slide quicker than last earning call as I think most of you are familiar with how to navigate it. So let's start with commissions; go down to Row 12. And commissions this quarter were $257 million or only $4 million lower than in the June quarter.

So if you jump over to Column B, let's go down to Row 11. And the net execution-only commissions decreased 17% to $76 million. The volumes related to this in Row 13 decreased 9% to 130 million trades, and that decrease came mostly from lower exchange-created volumes, particularly in our interest rate product businesses, which saw middle market and smaller clients, which tend to be more profitable, back away from this unprecedented volatility.

In Column B and Row 15, the execution-only yields were $0.58 this quarter, which was $0.06 or 9% lower than the previous quarter. And that decline is primarily the result of higher levels of the electronic business and a product mix shift as interest rate products activity has declined across the market.

Now in Column C, Row 11, net cleared commissions were $3 million higher from the previous quarter at $148 million. Now, although volumes were down 9%, the yield was up 13%. So the yield from clearing, Row 15, was $0.43 this quarter, which was a nickel higher than the June quarter, and that's as the mix of volumes shifted away from professional traders.

And as I said last quarter and I'll say it again this quarter, with mix shifts there are always going to be changes in these yields. But again, fluctuations naturally occur as the mix of customers, products and geography change.

Additionally, both our volumes and the associated commissions were both up from the June quarter. As Bernie mentioned, our metals business performed very well and those LME volumes are captured in the other or Column D.

So now let's jump over to the net interest section in Column H and go down to Row 3. The $60.2 million in this quarter was $6.4 million more than in the June quarter. Now the average balance down in Row 14 was $15.5 billion or 4% lower than the previous quarter. And the lower average balances were partially offset by an increase in yield of 23 basis points from the June quarter up to 1.56%.

I mentioned last quarter at the time we were taking a very measured approach to extending duration in our client funds invested to get a higher net interest income, and we achieved that higher yield. However, given the volatility that occurred in September we slowed down our efforts to extend duration as it appeared preferable to be invested in overnight securities given all the market dislocations. So today we remain cautious.

Now let's move over to the MF Capital column, or I, and in Row 15 you can see that the yield is nearly a full point higher than the client funds yield, and that's because the expense associated with these funds is either borne by the shareholders or by the debt structure and that expense is reported on the interest on borrowings line. So it's not a net yield. The decrease from the June quarter is wholly proportionate to the decrease in interest rates generally.

So now let's go over and take a look at the matched principal business, but let's start with Column G. Rolling up in Column G would be some of the things Bernie mentioned - Energy and Metals, Agriculture and Foreign Exchange. The total principal transactions increased net revenues by 10% over the June quarter. Metals had an exceptionally strong quarter, driven by significant volatility and price increases across many of the products we trade. The Forex markets experienced slower volumes, but that was largely offset by wider spreads in that business.

Now let's go to Row 4, the principal transactions. And what we've done this quarter is disclose the amount of principal transaction revenue related to the Securities Lending and Fixed Income businesses. Now the reason we did this is so we can better show you how we think about the yield on these businesses.

Now the best way to analyze principal transaction revenue is to combine it with the net interest that is generated from those transactions. So looking at Column E, Securities Lending, the market liquidity crisis this quarter caused a slowdown in securities lending. As a result of this market dislocation, the haircuts that get charged on these securities were so high that it made the business much less profitable. So this quarter we saw a 43% drop in the net revenues for this business. Now we'll look at the yields on this and the Fixed Income business on the next slide.

And then looking at Column F, the Fixed Income business saw a modest increase in net revenues of 8% by taking advantage of some of the anomalies which occurred between spreads and asset classes.

So how did the yield on these businesses do? Well, let's turn to our new slide, which will be Slide 12. And it's called the Fixed Income and Stock/Borrow Loan Yield Improvement. Now there are three things that I want to note about this slide.

The first is that we've combined these businesses to look at the yield in total. The second is that the average balances on the balance sheet generated by these businesses has decreased. And the third is that the yield has increased significantly so far this year compared to last year.

Now there are two reasons for combining yield on these businesses. The first is that the geography of the income statement means that the returns on these businesses are recorded both in principal transactions and in the net interest line. So to get the real yield, these lines have to be combined.

The second reason is that these businesses use the very security types noted above, and therefore they are interchangeable or fungible, so we need to combine these various security types to get a blended yield.

You can see that, since one year ago, the absolute balances are less than half of what they were, so we've significantly delevered these businesses. At the same time, we have emphasized those parts of the businesses that produce the highest yields. So in the last two quarters we've doubled the yield to 67 basis points on an annualized basis.

So many of you have asked us, how much have you delevered the balance sheet? So let's go to the next slide, Slide 13. And this is called Rationalizing the Allocation of Capital.

The Lehman Brothers event created a phenomena that locked up the repo market in the latter part of September. A lot of people fled to the security at U.S. Treasury bills and rates there approached zero, so the lender of the T-bill was receiving the equivalent of an interest-free loan. Now what this sparked was a record breakdown in this very long chain of lending and borrowing that characterizes the trade in the Treasuries between investors.

There was no incentive to return these instruments as the penalty rate for a repo fail was so low. As a result, the industry saw a significant increase in repo fails as sellers were unable to deliver securities because a failure to receive the same securities in settlement in another unrelated transaction. On our balance sheet, our $9 billion of failed to delivers created a spike in the receivables to brokers, dealers and clearing organizations line.

Since the end of September, fails have dropped to $2.5 billion and continue to drop. The fails are not a cost to MF Global because everything was trading at zero. In most cases we had the other side of the trade as well. So excluding the fails, we continued to delever the balance sheet, bringing it down another $4 billion this quarter and 44% since December of 2007.

Now turning to client payables, our balances declined by roughly $3 billion this quarter. Not surprisingly, we continue to see the large institutional clients sweeping their excess cash and this accounted for the vast majority of the decline in client payables this quarter. Now we summarized our balance sheet into those assets and liabilities related to client businesses, and at September 30 MF had $49.1 billion of liquid assets versus $46.9 billion of client liabilities. We will see on the next two pages how these changes impacted liquidity.

So what does this mean for shareholders? Well, let's go to the next slide, Slide 14, Strong Capital Position. When we take the liquid assets from the previous page of $49.1 billion and net off the liquid liabilities of $46.9 billion, the net result is net liquid assets of $2.2 billion. If we remove all the debt from the balance sheet of $1.3 billion, then what we're left with is liquid equity of $897 million. And this is a 13% increase in liquid equity from the last quarter as a result of our recapitalization.

So said another way, if we take all the assets and liabilities and we liquidate the balance sheet, we would immediately return to our shareholders approximately $900 million in cash. Assuming 120 million of diluted shares, that's $7.47 a share.

Now moving to the bottom of the page, we have a capital structure of $2.8 billion, and what we've done is we've included in our Appendix a schedule that shows the capital in regulated entities and the amount that is excess. We estimate the excess is approximately $800 million, of which much of that is in the U.K. Now this excess capital's available for spikes in client activity and allows us the headroom to grow.

So just how liquid is our balance sheet? Well, let's turn to the next slide, Slide 15, which is called Primarily a Self-Funding Matched Business, and you probably remember this from the last quarter. The top half of the balance sheet, I've simply taken the balance sheet slide and reordered it so all the client-driven activity is at the top half. And then the client activity determines the amount and the timing of the cash flow on the balance sheet. So the bottom half of the balance sheet is then how we utilize those funds. So we ensure these funds are liquid, they're safe and they're in high credit quality instruments.

So, as you can see, there was a decrease of $5.4 billion in client activity, and that is offset by a $5.7 billion increase in assets used for yield-enhancement activities, the difference being $300 million, which was the proceeds from the Series B and senior notes. Also at the bottom you see our net liquid assets of $2.2 billion from the previous slide.

So how are we investing these assets on the balance sheet? Well, let's go to the next slide, Slide 16, which is called Highly Liquid Low-Risk Assets on the Balance Sheet. Our client assets are invested in cash and liquid securities. On the left side of this slide are the client assets. As you can see, 83% are invested in cash and the balance in highly liquid CDs with high credit quality. On the right side are securities owned, and you can see that those are also highly liquid and of high credit quality.

Now in conclusion, I believe our results demonstrate that our primarily agency only model continues to effectively balance risk and reward, and that the diversification across product, client, geography has continued to deliver balanced results during some very turbulent times.

So I'm going to turn it back to Bernie, who's going to give you a big surprise and let you know who the new 44th president of the United States is. Bernie?

Bernard W. Dan

Thanks, Randy. So just before we open up the call for questions, I'd like to briefly highlight the areas which we're going to focus on in the next few months.

Collectively with our senior leadership, we are taking a hard look at the organization, with a focus on better management and governance practices. Our intention in doing so is to ensure we deploy our resources where they deliver the highest returns for shareholders and improve the long-term competitive position of MF Global. We are actively evaluating all of our businesses and working to better align our global teams to appropriately position the company to take advantage of current and future opportunities.

There are three areas of focus. The first, which is largely complete, is evaluation and assessment. For me this process began in the spring while I was consulting for a private equity firm, evaluating MF Global during its refinancing process. This behind-the-scenes look at the organization, its people and its investment theses made me realize that it had several sustainable competitive advantages. Given my exchange background and understanding of this space, I found MF Global's position in the market and long-term prospects exciting, primarily as a result of the company's scale, its primarily agent-only model, global distribution network, and unparalleled diversification across markets, products and geographies. This was, in fact, what prompted my initial interest in working with the company.

After proposing several recommendations to senior management to improve the long-term growth opportunities, I joined the company in June in order to execute on those opportunities. I immediately began meeting with key leaders within the organization as well as with clients to better understand strategic objectives, challenges and growth opportunities. These initial meetings validated my belief that MF Global's core attributes put it in an excellent position to take advantage of the opportunities that lie ahead.

Over the next month we'll be undergoing a strategic planning process with senior management to evaluate our short, medium and long-term opportunities to create value for our shareholders.

Second, we need to enhance our governance model and performance measures. We need to make certain we're allocating both our human and financial capital to highest return opportunities that are consistent with the company's overall risk profile.

As I mentioned earlier, we need to deliver scale to the organization. This will come through enhanced operating infrastructure as well as more profitable client relationships. Directionally we need the scale to take advantage of our industry leading distribution in order to gather more assets. This will help us diversify our revenue streams as we look to add fee-based opportunities to our interest income and transaction-related revenues.

The final phase is execution and ultimately delivering greater value. I believe shareholders will benefit from our efforts to continue to improve the efficiency and growth opportunities in our business. And as we consistently demonstrate that we can manage and control the business in a fashion that reflects the best interests of the shareholders, customers and employees, I'm certain that credibility and confidence in this institution will be restored.

As part of this ongoing effort to enhance confidence in the company, we will continue to have a strong philosophy of greater transparency and disclosure. Since Randy's arrival, the company has already made great strides in this regard, and we will continue to be proactive in our communication efforts. Our investors and analysts can be comforted by this approach and if we have material information, we will make every effort to disclose it to the market in a timely fashion.

So with that, Operator, we'll open up the call for some questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Roger Freeman - Barclays Capital.

Roger Freeman - Barclays Capital

I guess one question I'd ask is around the risk management. Obviously, it's definitely showing through here with the errors and bad debts being as low as they were. Can you just give us an update on what risk review is still ongoing? I believe there's still an ongoing review from earlier in the year.

And then, I guess, you also commented, sort of tied to this point around, you know, you showed your volumes being down more than the exchange comparables and you attribute that, I guess, to some positive selection on your end. Is that around the professional traders? Because you also commented that volume was lower. Have you been shutting accounts down?

Bernard W. Dan

Let me take the second part of your question, then I'll have Randy comment on the first. I'd say a couple things. One is, part of our risk process and procedures are, particularly this past quarter, was to identify areas of concern or accounts of concern as they pertained to Lehman or AIG or any other rumor that might have existed this past quarter. So those efforts, consistent with our focus to take measured risk in terms of driving value resulted in, at times, increased margins and/or collateral, and at times that may have resulted in clients trading less or anything of that nature.

And so I'd say that it's particular to this quarter and I think it shows the flexibility of our risk management procedures and systems and allows us to apply that system and processes in areas where we think there is potential risk for us.

And then let me have Randy kind of comment on the first part of the question.

Randy MacDonald

Yes, with regard to everything that happened with the Board, I mean, that's concluded. I think what you might be referring to, which is the only real open item, is with Moody's. Moody's has us on what's called negative watch, which has nothing to do with our ratings, upgrade or downgrade. That would be negative - I'm sorry; it's the other way around. I wrote down watch  negative outlook.

So they have been here. They have asked us for a few things, but they met with Mr. Roseman and his colleague, [Tracy Wiley]. But essentially there's a short list of things they like to further see and explore, but I'd expect that to take care of itself over the next weeks.

Roger Freeman - Barclays Capital

And then I guess just with respect to the competitive environment, have you benefited from the dislocation among some of the other larger broker dealers with respect to gaining market share? Again, sort of the volumes don't necessarily reflect that, but I guess if you could just sort of talk to [flows] that you got there.

Bernard W. Dan

I'd say clearly we've benefited from my comments of all the new accounts we've generated over the last several months, and that's including areas coming out of Asia, out of Europe, out of the U.S. We've clearly benefited from that, number one.

Number two is clients recognize the value of scale and the cash flows that we generate, so we're still an alternative to smaller FCMs who frankly don't have the scale or may not be able to withstand potential deleveraging by hedge funds or other clients in this environment.

And three, we clearly have an advantage in the fact that we don't have significant or any material proprietary trading activities which in fact compete with our clients. And so as a preferred counterparty, we are viewed very, very strongly.

And I'd say also, just to close on that, is that clearly customers in this environment have also been sweeping assets and becoming more conservative. And given the volatility, certain profiles have clearly pulled back activity. That's to be expected when VIX is at 80.

So I think the real story about this quarter is really the diversity of our model, whether it's geography, product or customer, that allowed us to deliver revenues consistent with last quarter. And that's the real story and that shows the global scale and the distribution we have that can weather various economic situations that we recently just experienced.

Roger Freeman - Barclays Capital

Are the cash sweeps even seeing - where's that money been going to, FDIC insured accounts or Treasuries?

Bernard W. Dan

We're sending it back to our customers. It's customers saying hey, I have to place those assets in either a different investment, I need to call somewhere else. We don't know. It's wherever they ask us to send it.

Roger Freeman - Barclays Capital

Just with respect to duration, Randy, you commented that you've gone back to the short end now with some of the short-term funding markets showing some signs of stabilization. Are you starting to move back out or are you still sort of taking a wait and see?

Randy MacDonald

Yes, it's wait and see right now. I think - Don, unfortunately, is out sick; otherwise we'd have him on the call and maybe give a little bit more color, Don Galanti, our CIO - but right now I think we're being fairly cautious. We still are not convinced that all the banks that are counterparties are completely stable, and I think I'd like to see how the next week or two shakes out.

Operator

Your next question comes from Kenneth Worthington - J.P. Morgan.

Kenneth Worthington - J.P. Morgan

MF is a company that was built through acquisition, but based on your comments it seems like your focus is really internal at this point. Is it fair to say deals are kind of off the table for the foreseeable future?

Bernard W. Dan

Ken, what I'd say is a couple of things. First of all, the focus short term's internal because we want to get full integration of our platforms, introduce global standards, reduce some of the complexity associated with technology, and offer a seamless solution for clients really anywhere in the world and across multiple geographies. That will contribute to pre-tax margin percentage growth that will be very beneficial for shareholders. That's point one.

Point two is simultaneously, you know, that will set the stage for us to take advantage of what I perceive will happen in the next several quarters - consolidation again within our industry amongst these smaller and midsized competitors of ours. It will be very difficult I think for them in the mid to long term to maintain high levels of profitability.

So part of my focus kind of internally in stressing that is to get this company in position in short order to take advantage of further acquisition opportunities, and that's going to be on an opportunistic sort of basis, recognizing some of the volatility that exists within financial services and I think will continue to be part of our environment for the next several quarters.

Kenneth Worthington - J.P. Morgan

You had a discussion on the income statement and comp and non-comp. As we look at noncompensation expense, how much of that is variable right now? I'm just trying to get a sense of, as the revenue grows, what kind of growth should we see in the noncomp expense as well?

Randy MacDonald

Yes, I think I have to come back to you in the future. Part of what I tried to do is create some better sensitivity around the income statement. That's a work in process.

Kenneth Worthington - J.P. Morgan

And then lastly, right now, to try to get a sense of some different risks on the balance sheet, to what extent do you have non-secured credit lines out to customers and how much of that has been drawn down? In the past it's been small, a couple hundred million bucks, but I don't know if it's grown or shrunk or what's happened with that.

Bernard W. Dan

Look, it's historically been small and one of the comments that I made in my comments about risk processes is we've moved to introduce in some of those clients that have lines greater collateral and/or reducing lines and/or introducing intraday margin calls. So the scope is significantly lower and it's a reflection of just the environment. And I think clients understand the environment and as comfort level increases and there's more stability as we move forward, our opportunity to extend greater amounts of those lines we will deem when appropriate.

So I think it's a normal reflection of kind of what's going on in the industry and it's a responsible way to manage this particular period. So they're a little bit lower.

Operator

Your next question comes from Christopher Allen - Banc of America Securities.

Christopher Allen - Banc of America Securities

Just on Slide 12, can you give us any rough breakdown in terms of how the average balances break down between the Stock Borrow and Fixed Income books?

Randy MacDonald

Well, we purposely didn't do that because, frankly, I mean, the science there is not as important as managing those two businesses together, because a lot of the securities - there is a lot of interplay between what the Fixed Income desk does and how we are managing the MF Capital and the client payables. And I mentioned in my remarks, that interchangeability and fungibility.

So we purposely are looking at it on a combined basis to get you the combined yields, because that's really how we run the business and how we think about it.

Christopher Allen - Banc of America Securities

And then, Randy, you just mentioned the yield on the execution business came down because of a shift in the electronics side then a shift towards rate products declined. I mean, when we look at the exchanges, rate products are typically the lowest RPC, so it's a bit counterintuitive from what we would normally expect. I mean, if you could just give us some color on that, that'd be appreciated.

Bernard W. Dan

I'd say a couple things there. One of the things that's happened in maybe the second quarter or, from our perspective, the last quarter, I would say, is within the industry is maybe some of the medium to smaller size players generally speaking have shied away. So that's created a concentrated level of activity amongst maybe the larger participants within this industry and within this company that tend to have some of the lower rates, okay? So Randy kind of generally focused on mix.

So this particular quarter focused a lot on that, where we have, you know, large clients trading proportionately significantly larger amounts of volume than maybe our balance portfolio. So that's really what you're seeing, and those are at just lower rates. And that's clearly in the interest rate sector, which is where most of our execution-only business originates from.

Christopher Allen - Banc of America Securities

Have you guys seen any material change from a credit issue perspective since the end of the quarter into the new quarter, just given all the issues we're seeing on the hedge fund side?

Bernard W. Dan

No. I mean, Chris, specifically why I made my last comment, you know, that our focus is on transparency and greater communication. If we had anything material to report, we would do it. But the answer is no.

Operator

(Operator Instructions) Your next question comes from Michael Vinciquerra - BMO Capital Markets.

Michael Vinciquerra - BMO Capital Markets

I want to follow up on two of the other questions. First, on the interest income, Randy, can you give us an idea about where we exited the quarter and then also the impact of the Fed cuts in terms of where you think a range on the yield might be on client funds for this quarter?

Randy MacDonald

Yes. Clearly a cut in rates is not helpful to us, so I think what we have to do is find opportunities, like we did this quarter, to match off asset classes where we can actually get a yield. And I think that's actually what our Fixed Income desk and [Peter McCarthy] and Don Galanti, in particular, do very well.

So I can't really - I hesitate to tell you what I would want to do or what they would want to do because it is dynamic, number one. Number two, I also don't want to sort of foreshadow some of the things, the strategies that they employ.

The first question I'm not sure I understood.

Michael Vinciquerra - BMO Capital Markets

Well, basically, the first thing is, on the fed funds rate, down 100 basis points this quarter. How much of that passes through to your yields do you think roughly? Do you have a sense for that?

Randy MacDonald

Well, I think that was the answer to your question, what I gave you is it is not helpful, but that is the point, how do we try and mitigate that. As a general rule, because our assets are so short in duration, you would think it would have an immediate impact. We do have some in the portfolio that is extended; it does have duration and so it wouldn't impact that part of the portfolio.

The right side, there are many balances. Bernie mentioned nearly 30%, 35% of the balances are Retail, where we don't basically pay anything on those balances. So those are of long duration, but all the other assets, they do reprice almost immediately based on 30 to 90-day T-bills. So I'd say the only exposure we have is, frankly, on the 30%, 35% of retail balances.

And I guess my point is that that's where Don and the Fixed Income team come in. There are so many anomalies in spreads and so many opportunities with asset classes that they've done a good job this quarter of blunting that or mitigating that. So I can't - we don't give guidance, number one, but number two is I think this is a pretty dynamic process that we go through.

So I wish I had a better way of giving you sensitivity but, as I said, I think we have to go through another few quarters before we're able to produce a real good sensitivity model for certain of these key inputs.

Michael Vinciquerra - BMO Capital Markets

And then following up on Chris's question on the RPC, is it possible for you to rank order for us, without giving us anything specific, but rank order the products in terms of the average RPC across your client base, you know, between rates, Forex, equity, that type of thing.

Randy MacDonald

Now we're getting into real competitive information that would be - I would tell the team we would not want to [inaudible].

Bernard W. Dan

I agree with Randy. I mean, look, Mike, we have certain segments that are priced in a certain manner and that's one of our competitive advantages in terms of what that mix is, and so what we're going to try to reflect is a broader yield. And what we're concentrating on is to leverage the various components within that yield, and we're just not going to be in a position to share that.

Michael Vinciquerra - BMO Capital Markets

Okay. I would assume they're kind of similar across your competitors in terms of those products. But one question, Randy, and then I'll get off. The GAAP reconciliation table you have in the press release showing the $19.4 million in net income and then you had 168 million shares, you've come up with a $0.14 non-GAAP number. When you do the math it's only about $0.115. What's the reconciliation between the $0.14 and the $0.115 I'm coming up with?

Unidentified Company Representative

Yes, sure. Because this is on an adjusted diluted basis, when we calculate our adjusted or nonGAAP EPS you have to add back to your net income any interest earned on the convertible debt because on a convertible basis what you would do is [you've sort of] now converted all of your convertible debt instruments into shares, and so you wouldn't have interest expense going forward. So that would be the difference.

Michael Vinciquerra - BMO Capital Markets

And that amount is roughly?

Unidentified Company Representative

I think it's around - yes, I think it's around $6 million in total, but you can go to one of the Appendices where we show in detail the non-GAAP EPS calculation.

Michael Vinciquerra - BMO Capital Markets

Okay, so just take that $6 million that we saw in the release and just tax effect it and that's the difference?

Unidentified Company Representative

Yes. And you add it back, yes.

Operator

Your next question comes from Richard Repetto - Sandler O'Neill & Partners L.P.

Richard Repetto - Sandler O'Neill & Partners L.P.

The one question I had is, I guess, Bernie, I know there's lots of opportunities as more OTC stuff looks like a good potential to come on exchange or hopefully it will, but I guess how do you balance the opportunities with the potential deleveraging of customers? I know volatility has been high and that's certainly helped in the near term, but are you seeing anything that could indicate that, at least from the existing customers in the hedge funds, is there a balance there for '09 as you look at it?

Bernard W. Dan

Rich, I think it's a good, good question and let me give you a couple points to think about. And frankly, this is why MF Global's such an attractive model.

You know, we have mass businesses in Asia, Europe, North America, around the globe. We have product lines that are very deep within this company and very leading in certain parts of the world, for instance, a very strong equities business in London. So we have opportunities to expand core businesses in certain parts of the world into other parts of the world.

So the diversity of products and the regions gives us a unique advantage to ensure we're offering all of our product suites - whether it's equities, FX, fixed income, commodities, whether it's listed or OTC products across an array of products - our goal is to ensure that those offerings are consistently offered around the world on common systems.

And so the first point of that is we have a lot of what I would call organic opportunity to enrich the product and service offering we have kind of on a regional basis and make it global is point one.

Point two is that our customer base is extremely diverse. We have large, small and medium size financial institutions. We're made up of commercial hedgers. We have the largest collection of professional traders. We have the largest retail broker. We have managed futures funds. We also have hedge funds.

So that diversity of client base allows us to deal with something that's probably well anticipated, at least from this company's perspective, as just, you know, potential hedge fund redemptions and what that means on trading. So I feel very comfortable that that diversity can get further supported through product and service offering.

The other point I'd make is we're going to have significant, in my judgment, efficiency opportunities where the cost and the global platforms we have will be less complex and, as a result, less costly, so that what we deliver to the public across this geographic sort of penetration and the leveraging of all of our product strengths is just going to get greatly enhanced.

And most importantly, I do think because of the deleveraging of hedge funds, it's going to put pressure on our competitors who don't have the global footprint that we have, and that's where this company, I think, can be in a position to be very prudent, yet very aggressive as I just picture another round of consolidation which, frankly, this company's been very good at accumulating and buying and integrating other companies. And I just want to get into a stronger position so that when we do it, the net new revenues we basically combine and anticipate to combine in this company will fall to the bottom line.

So for me it's a huge opportunity, the way I see it. And I think we're balanced and diversified enough to withstand any sort of volume slowdown associated with hedge fund redemptions.

Richard Repetto - Sandler O'Neill & Partners L.P.

The severance that you're going to take in the coming quarter here, how much is related to Kevin Davis? I know there's a lot of scrutiny on severance and CEO severance packages, etc.

Bernard W. Dan

7.5.

Operator

Your next question comes from Robert Rutschow - Deutsche Bank Securities.

Robert Rutschow - Deutsche Bank Securities

My first question's on client funds. I'm wondering if MF has sort of, I don't want to say suffered but has seen client funds sort of gravitate away with the flight to quality in the current credit environment and if there is anything that you can do to sort of encourage more marginal cash to stay with MF Global?

And then secondly, what the duration of those client assets might be, if you've done any work on that.

Bernard W. Dan

I think a couple comments is that I think we showed in that one chart how net revenues can increase from both a volume and a revenue perspective through new client accounts that really are not correlated with client assets. So I think we have to keep that in mind is point one.

Point two is that clearly we've also mentioned that excess funds have been swept this past quarter, which is clearly individual client decisions, whether it's a flight to quality, as you reference, or for other reasons. We've experienced that, as have other intermediaries within this space.

Three is one of the things I made in my closing comments. We have worked hard to improve our risk management systems and deal with some credibility issues that dated back from the [Dooley] incident. We've clearly demonstrated through the most volatile quarter that the improvements and the changes we've made have been very, very productive and positive in terms of mitigating risk.

And so one of the things that we're all focused on is restoring that confidence and credibility, and the best way for us to do that is to make these incremental steps so that all the other attributes of this company get magnified in the eyes of clients. And that's what we're going to be broadcasting.

Conversely, the quote-unquote flight to quality also means clients are entering a different type of risk, that of potentially conflicting with proprietary trading desks of those quote-unquote perceived flight to quality is point one.

Point two, the flight to quality comment, remember, they're going to companies that had very, very poor risk management systems that contributed to the worst financial crisis since the Depression. So what we're trying to demonstrate is that the independence and the system changes we've made are going to create the necessary platform for them to feel comfortable A) as a counterparty, to be a counterparty [at] MF Global, and B) enjoy the listed regulated futures and options industry and enjoy the benefits of segregation.

So I think what your comment is now is maybe a short-term phenomena on how people are really viewing quote-unquote risk. And I think when they begin to understand kind of what decisions they might have made in terms of flight to quality pursuit, I think they'll recognize that their risk is better balanced with an independent company like MF Global.

Randy MacDonald

And Rob, just to follow up, I think one other thing that Bernie said in his remarks is, as we become more of a company that allows clients to trade across geography and multiple products, etc., there's more of a tendency to leave the excess because the money's fungible across geography and product.

With regard to a deposit study, we have not done a deposit study, so I hesitate to make a guess as to what the various layers are of our deposits. Obviously, some of them are extremely long dated because they've been here for many, many years. So we are endeavoring to do that, and that's something I have - we've hired a new global treasurer, David Dunne. David was most recently head of treasury at Bear in Europe, and part of what I've challenged him to do is understand better our deposit base and the age so that we can feel more comfortable extending the duration on our assets.

Robert Rutschow - Deutsche Bank Securities

Is there any chance that you guys will be eligible for a TARP investment from the Treasury?

Randy MacDonald

No, you have to be a member, which we are not. You also have to have experienced all these incredible losses and have this incredibly toxic product. So thank goodness we don't - the good news is, no, we don't.

Bernard W. Dan

Rob, we're going to run our business on our own capital.

Robert Rutschow - Deutsche Bank Securities

I wanted to also ask about the recent, you know, we've seen a pretty big move in a lot of currencies recently, so I'm wondering if you can just give us an update on what your exposure is to these various currency moves in terms of your earnings impact?

Randy MacDonald

If I understand the question, this is essentially we are holding money in foreign countries that we experience gains or losses locally. What we will do is hedge that out.

Robert Rutschow - Deutsche Bank Securities

Actually, I was kind of asking more in terms of your earnings from Europe are going to be obviously worth less or earnings from Asia are going to be worth less as the dollar strengthens, so is that fully hedged? And maybe you could just help us kind of size those different markets for you.

Randy MacDonald

It is an amount of money. Like, for instance, I mentioned in my remarks that last quarter it was $4 million, right? This quarter it swung the other way. It is an amount of money, but it's sort of noise.

Bernard W. Dan

Rob, I'd also say, for the significant profile of our institutional business, whether it's in Europe or Asia, are dollar-based revenues.

Robert Rutschow - Deutsche Bank Securities

I was hoping you might be able to comment on what you're seeing among your managed futures and hedge fund clientele in terms of their activity levels and if there's any differences there. And then just broadly what you're seeing and what we might look for volume wise going forward.

Bernard W. Dan

Rob, I think I mentioned that, for this particular quarter, our volumes were down and a little bit below the sector, so I think it's safe to assume that some of the deleveraging that another caller asked about is happening A) within the industry, and B) we've been part of that.

And I also went on to say we view that as something that's kind of particular to this quarter and maybe particular to something in the near-term quarters, but not a long-term trend. And so I think it's one of these things that we're well diversified, we're well balanced in terms of our approach, and as we've demonstrated this quarter, we're opportunistic in ensuring that we're maximizing kind of our revenue opportunities across transactions, whether it be execution, clearing or, in the case if interest income, yield.

So what we're focused on is making sure we're managing effectively through this period because we recognize that it's not going to last forever. And so I think to comment specifically on any customer movement or what it means to us, I think, is just - it's not, frankly, I think very helpful, number one, nor, two, is it directionally kind of something that's going to be long-term representative of what our opportunities are.

Operator

Your next question comes from Jonathan Casteleyn - Wachovia Capital Markets, LLC.

Jonathan Casteleyn - Wachovia Capital Markets, LLC

I'm just wondering if you can articulate a reasonable timeframe for the efficiency upsweep or the full integration you're talking about? And is there an earnings impact when this is closer to completion or is it just more efficient risk management?

Bernard W. Dan

Jonathan, I think a couple of things. It's going to be kind of evolutionary in nature, and so we have some short-term opportunities from an efficiency perspective which will create some opportunity and, by default, allow us to fund changes. And so it's kind of a general thing.

And two is that we don't have timeframes on it, but I think what you'll see is this quarter by quarter updates in terms of what drove results. And we'll point to certain actions that contributed to this. And it's more going to be about how you see the incremental change of this company, and that's really all I'm going to comment on.

Jonathan Casteleyn - Wachovia Capital Markets, LLC

And then just, Randy, I don't know if I interpreted this correctly, but did you say you had one full turn of EBITDA against your debt covenants? And I'm just curious if you can review those debt covenants at this point.

Randy MacDonald

What I was saying was that we have one quarter of EBITDA as headroom against the most stringent covenant. That's the easiest way for me to think about it.

Jonathan Casteleyn - Wachovia Capital Markets, LLC

And this quarter's EBITDA was $60-something million - $61 million?

Randy MacDonald

Yes, exactly - 66.

Operator

There are no further questions at this time. I will turn the call back to management for any closing remarks.

Jeremy Skule

Okay, I just want to say thank you for your time and attention today. We appreciate your interest in MF Global and look forward to future conversations. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in MF Global's fiscal second quarter 2009 earnings conference call. This concludes the meeting; you may now disconnect. Have a good day.

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