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BlackRock, Inc. (NYSE:BLK)

Q4 2008 Earnings Call

January 21, 2008 9:00 AM ET

Executives

Robert P. Connolly - Managing Director and General Counsel

Ann Marie Petach - Managing Director and Chief Financial Officer

Laurence D. Fink - Chairman and Chief Executive Officer

Analysts

William R. Katz - Buckingham Research

Roger Freeman - Barclays Capital

Mike Carrier - UBS

Roger Smith - Fox-Pitt Kelton

Craig Siegenthaler - Credit Suisse

Robert Lee - Keefe, Bruyette & Woods

Operator

Good morning. My name is Dennis and I will be your conference facilitator today. At this time, I would like to welcome everyone to the BlackRock Incorporated Fourth Quarter 2008 Earnings Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Ann Marie Petach and General Counsel, Robert P. Connolly. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (operator instructions). Thank you. Mr. Connolly, you may begin your conference.

Robert P. Connolly

Good morning. This is Bob Connolly. I'm General Counsel of BlackRock.

Before Larry and Ann Marie and Sue Wagner, our Chief Operating Officer is here with us this morning as well, make their remarks, I want to point out that during the course of this conference call, we may make a number of forward-looking statements. We call to your attention the fact that BlackRock's actual results may differ from these statements. And as you know, BlackRock has filed with the SEC reports which lists some of the factors which may cause our results to differ materially from these statements. Finally, BlackRock assumes no duty to and does not undertake to update any forward-looking statements.

And with that, I'll turn it over to Ann Marie.

Ann Marie Petach

Good morning, everyone. My comments are going to be on an as adjusted basis, unless I note otherwise.

Starting with the facts. Full year operating income was $1.662 billion or $8.37 per share, that's up about 9.5% from a year ago. Non-operating losses net of minority interest were $381 million or $1.92 per share. Net income was $858 million or $6.45 per share, that's down 21% compared to a year ago.

Full year revenues were up 5% year-over-year including a 6% increase in base fees. While we are proud of our relative performance, we are disappointed in the market effects and our absolute results. The 9.5% improvement in full year operating results and the 5% revenue increase reflects very strong net new business flows in the first half, exceptional growth in the advisory business, a balanced business model and strong cost management discipline, dampened by extremely negative market effects in the second half, particularly in the fourth quarter.

As mentioned, the results reflect proactive cost management. Our GAAP results include a $38 million restructuring charge associated with a reduction of about 500 people or about 9% of the workforce. This action was taken to align our workforce for present market conditions. The full year as adjusted comp-to-revenue ratio was about 35%. That's equal to a year ago despite market effects on revenues and full year effects of employees added in the second half of 2007.

In addition, full year G&A improved over $100 million compared to 2007. Half of the improvement is explained by balance sheet-related foreign exchange effects of almost $50 million, that includes about $30 million in the fourth quarter. $26 million of the improvement relates to lower expense related to 2007 support of cash funds and $26 million relates to lower closed-end fund launch costs. We also managed to lower marketing and T&E despite a major rebranding in Europe. This was offset by higher occupancy costs related to the Quellos transaction.

Full year operating margin as adjusted was 38.7%, an improvement compared to 37.5% a year ago, driven by revenue growth combined with aggressive expense management.

As was discussed before, BlackRock utilizes its balance sheet to co-invest capital alongside our clients and to seed new products. The majority of these commitments are invested in alternative products and are invested alongside with clients for the duration of the product. These co-investments are generally long-term commitments from real estate, distressed products, hedge funds and private equity.

BlackRock also seeds new products. These investments are a much smaller portion of the portfolio, are shorter term in nature and are hedged as appropriate. Almost all of the balance sheet investments are mark-to-market. The extremely negative markets in 2008 have affected our clients and BlackRock's results.

This alignment is important to our clients. 2008 markets, particularly the fourth quarter, were not kind to anyone. The full year non-operating loss of $381 million represents about a 25% decline from the peak investment portfolio of about $1.4 billion in June and is in line with market movements on underlying assets. This brings the portfolio to about $1 billion, distributed as discussed previously. The hardest hit asset classes included distressed credit, which represented about $140 million of the loss; real estate, which represented over $120 million, and that was across multiple investment; hedge funds which represented over $50 million of the loss and private equities, which represented about $30 million.

As a reminder, many of these investments are long term in nature while the marks represent the market valuation of the portfolio at a point in time. The majority of the marks do not reflect BlackRock's expectation of holding these investments for a long period nor in our opinion the true economic value of many of these investments.

As a result of the magnitude of the U.S.-based non-operating losses recorded in the fourth quarter, the mix of our pre-tax income shifted such that a greater percent of our income than originally anticipated was realized overseas in lower tax jurisdictions. This resulted in us making a fourth quarter adjustment to our full year tax rate, bringing it down from 35% to 33%.

I want to share with you a few other thoughts regarding the fourth quarter. This period most clearly reflected the headwinds of adverse markets affecting our results. Fourth quarter as adjusted operating income was $371 million or $1.81 per share. The as adjusted non-operating results were a loss of $270 million or $1.32 per share. The change in full year tax rate from 35% to 33% contributed $0.19 per share. As a result, net income for the quarter was $91 million or $0.68 per share. As adjusted, operating results were down 15% compared to the third quarter and down 24% compared to the fourth quarter of 2007. Revenues of $1.1 billion were down 19% compared to the third quarter and down 26% compared to the fourth quarter of 2007.

Fourth quarter market and foreign exchange movements drove revenue declines compared to the third quarter and compared to a year ago. The most material and important effect was on base fees, particularly on equity products. Base fees, which represent 80% of total revenue, were down over 20% compared to prior periods and equity and balanced declines represented 80% to 90% of that total.

In addition, we earned lower performance fees, which are often dependent on absolute performance, a difficult threshold in this market.

Finally, we saw a decline in other revenue, explained by decline in securities lending and the disposition of our Metric Property Management business, basically a zero margin business. These factors overwhelmed the strong growth in our advisory revenues.

Aggressive expense management in the fourth quarter explains the as adjusted operating margin of 41.6% and the 30% decline in compensation expense compared to prior periods. Fourth quarter G&A expense of $154 million is down $16 million from the third quarter, again reflecting the effects of our cost control efforts, particularly in the areas of marketing, promotion, T&E and technology. We plan to continue to aggressively manage cost as appropriate for the environment and for strong long-term business results.

In summary, hostile markets have affected all segments, including our business results. The fourth quarter showed the headwinds on revenues. We begin 2009 with market affected assets under management. We are proactively managing our cost base and will continue to do so. Still, the overwhelming market influence on revenue will affect our operating margins. We remain committed to co-investing in alternative products with our clients, which facilitates us being a full platform provider. So it has introduced earnings volatility.

At the same time, we are pleased with our relative position. Our business has grown and our operating results improved compared to 2007. We have a diversified business by asset type, client type and region. We believe this will continue to provide balance to our results and growth opportunities over time. Our Solutions and advisory business have grown; we are seeing continued opportunity in an adverse market.

Our risk management and diversified asset sales are bringing in significant new opportunities. Our pipeline remains strong at $59.5 billion. I believe our 2008 operating results are reflective of our business platform and approach. This approach puts us in a position to do relatively well in adverse markets and exceptionally well when markets turn around.

With that, I'll turn it over to Larry.

Laurence D. Fink

Thank you, Ann Marie. Good morning everyone. I said recently in an article in one of the newspapers that 2008 was the best and worst of times.

So, obviously, one of the worst of times because of asset value destruction, collapse of liquidity and outright fear. We have seen all this create a paralyzed global market. And we expect that to continue, as I said in the article about... for the next three to six months until we see some stability from... essentially from our global central banks providing liquidity and buying troubled assets.

These are the best of times in terms of BlackRock's position. I believe, more than ever before, our business model has proven to be on an absolute basis and most certainly on a relative basis to be resilient and responsive to our client needs globally, domestically, institutionally and retail. I believe we are in a better position to work with our clients than ever before.

Our clients worldwide are struggling; not just our small retail investors, but our sovereign wealth funds, our pension plans, our insurance companies. Everybody is asking questions, looking for help, looking for a complete analysis of what should be done with their portfolios. And I believe our platform, our unified platform is as well positioned to help our clients navigate this than many if not most of our peers. And most importantly, I believe we are being asked questions by our clients more today than ever before as to how we could help them navigate these turbulent markets.

So these are the best of times for us on a relative basis. These are the worst of times in terms of the relativity in the marketplace and the results of the marketplace and the disruption of asset values.

Let me review the fourth quarter in a little more detail. And I should note that I believe our fourth quarter release is pretty exhaustive in terms of information we're providing to all of you. We took a lot of time in trying to explain everything by asset category. And I believe it's more transparent than ever before and we are trying to give more information on a timely basis. Obviously, there is going to be a lot more information provided as we issue our 8-K and our other financial reporting. So let me go over some important points about BlackRock.

We are very thrilled about where we ended up in terms of AUM. We had growth in AUM. Most firms exhibited massive destruction in AUM in the fourth quarter because of resiliency of our business and the diversity of our business products, we exhibited about a $49 billion net increase in assets. So we have crossed over again to the $1.3 trillion asset base.

Now obviously we saw a very large swing in assets. We saw large outflows at times in long-dated funds. We saw large inflows in liquidity; I am going to go into those in a little more detail. But importantly, our BlackRock Solutions and advisory business has really transformed our asset growth and helps us continue to grow. And I believe once again, our business platform of having a complete product profile of alternatives, equities, fixed income and advisory is going to allow us to continue to drive new business growth.

So $49 billion of net new growth. That was on top of an $80 billion market decline in just our portfolios. $80 billion is pretty shocking, but it also exhibits how hard the market fell in the fourth quarter. That is entirely beta and actually in most of our equity accounts in the fourth quarter, we outperformed. So if we did not have positive alpha in our equity accounts in the fourth quarter, we would have had even more price destruction. And so I know these numbers are shockingly large and yet it just exhibits the pain and suffering that the capital markets had in the fourth quarter.

But we've been able to navigate through that, we've been able to build business and as a overall platform, we have been able to transform ourselves and build more relationships.

I would like to also say we have more clients today than we did at the end of 07 and we have more clients today than we had at the end of the third quarter of 08. So we are winning business, we are picking up clients and we are picking up multiple client activities with our clients.

As Ann Marie noted, our pipeline remains robust with close to $60 billion in new pipeline, of which $21 billion are long-dated mandates.

I'd like to note that in the last week or so, we are starting to see more clients' activity, and this is one of the reasons why we've seen an increase in these long-dated mandates in the first quarter. We are still seeing clients restructure. We expect to see clients restructure in a great way. Some clients are going to be moving more and more out of alternatives as they are short liquidity, which I will talk about in a while. They just have too much illiquidity in their portfolios. So they are trying to simplify their portfolios.

Some clients are taking a more active approach to try to buy more, I would say, riskier assets now and some clients are looking to immunize portfolios by buying long-dated credit. Some clients are looking to now sell bonds and fixed income as they go into equity. So we are seeing, depending on the clients needs, depending on the nature of their liabilities, we are seeing tremendous changes in client behavior.

Let me just talk before I get into the details of our different businesses. Let me just firstly hit on non-operating.

Ann Marie told you really where all the hits were, and I think our release does explain it pretty carefully; down 25% from the high level of our assets that we achieved in 08. It is reflective of the market. Most of these investments are investments with our clients. I would like to also just note and very strongly note, we do not have portfolios that are held to maturity. Everything we have in our balance sheet we flow through income.

And so as Ann Marie said, it took some earnings volatility and yet I would tell you our strong position with our clients necessities sometimes a co-invest with our clients and we are going to continue to do it. We believe it is the right business model. In the long run, obviously, if I knew we were going to have price destruction like we've had, we were bearish but not that bearish, we would have probably thought a little differently.

I would also say we do not hedge any of our exposure in these products. We do hedge at times the beta of equity markets when we are seeding equity-like products. But in the alternative space like real estate, like co-investing in our fund of funds of hedge funds and the fund of funds of private equity and real estate, we do not hedge. We are going along with our investors on these products. And at times when we had great returns in the upside, we benefited and obviously a 25% decline in these assets are quite startling. But we believe we have been very aggressive in terms of marking these assets. If there is still more price destruction in 09, we are... we will probably see some destruction in those asset categories.

So I am not here to tell you that it's going to be upside forever after this. But I will say we have been very aggressive in terms of the marks. We actually like the cash flows that are being thrown off from these investments; certainly some of the investments are showing up huge cash flows now. And as Ann Marie said, we do not believe the majority of these assets will have permanent impairments. We do believe once markets will normalize that these assets will come back and we will have some gains that we will be able to recognize as we mark-to-market the assets upward when the world stabilizes, which, unfortunately, I don't believe we are going to see that much stability at least in the first six months of this year.

As Ann Marie discussed, and it is in our offering, of the loss of $124 million was losses in our seed investments, $91 million loss was in our various real estate products. I should state we do have about 30-odd billion dollars invested on behalf of clients in real estate. So these are just smaller components of the seed. So they're across many portfolios.

And we were very aggressive in terms of marking our fund of fund business, especially the private equity area. We don't have the returns back for most of the advisors who we have our fund of fund products that we co-invest with, we don't have their results back. But we were taking strong estimates as to what we thought would happen in the private equity area.

As Ann Marie also stated that we will continue to co-invest with our clients in this business and we believe this will be an important component of our future growth.

Let me spend some time now on our core businesses in the fourth quarter. Let me start out with equities. We had a great relative year; 59% of our products were above the benchmark or above peers. In a chaos market like it is, like it was in 08, I believe the returns are tremendous. Our three year returns, 81% of our products are above our peers and benchmarks.

Our Large Cap Series under Bob Doll had ended up the year with very positive performance. Our UK equity team, our European equity teams had very strong performance. And I do believe when equities become the product of choice again in both mutual fund and institutional channels, we are going to be one of the beneficiaries of that.

I would like to also note once again the outstanding performance with our Global Allocation Team. I would like to also just identify this is the sixth largest net funds product in the U.S. in 2008.

We are very well positioned. We believe this is a product that is going to continue to grow and continue to be one of the large new products that are going to be sold when equities become back in vogue. Obviously, this is a product that has an allocation of 40% in fixed products too. So it's not just equities. So for clients who are looking for a global allocation product, this is one of the best-in-class. It is recognized, it is in the first quartile of performance now for many different quarters and years. So we are just very well positioned in the equity product areas.

We also did a very good job in terms of selling our products overseas. We were one of the top net product... mutual fund sellers of products in our Luxembourg channel where our... that's where we domicile our European equities and so we are just very well positioned in equities. And I believe once the market stabilizes, this will represent a very positive growth product for BlackRock.

Now obviously, in the fourth quarter, we saw large outflows in equities as people felt frightened of equities and equity performance. A lot of that money went into liquidity products. But we believe over the course of a long cycle, as long as we have the proper teams, the risk management tools and the performance, we will be a huge beneficiary of this.

On the fixed income side, we had mixed performance. We had actually very strong performance in our specialized fixed income products. In corporate products, in tips (ph), in emerging market products and our UK equity products were very strong. We had poor performance in our multi-product sector portfolios, but... on a relative basis versus the index. But we actually did quite... much better than a lot of our peers. And surprisingly, we are winning a lot of assignments even in the multi-product area because of our relative performance versus some of our peers. This is something that we are focused on. Obviously, we would like to have a complete story about all our fixed income products doing well. But in some of the areas, we did not have as great a performance.

In alternatives, we are seeing sea changes, we are seeing business changes dramatically in the alternative space. As I suggested earlier, clients, many clients were just overly committed into the alternative space. Clients in many cases did not appreciate the nature of liquidity. And so many clients today are facing real issues surrounding liquidity. Many clients are challenged with their over commitment in some of the alternative areas. And so we are working with some of our clients in trying to help them obviously in their liquidity issues.

This is an industry problem; this is not a BlackRock problem, but an industry problem that we are a part of. We have no Madoff exposure in our funds, in our products, in our firm. We are well positioned relative to most of our competitors. I do believe the Madoff scandal. I do believe the turmoil with a lot of... many other financial institutions will put BlackRock in a very good position in the alternative space. We believe as clients reconcile their liquidity issues in alternatives, and I am talking fund of funds, I am talking real estate, I'm talking about specialized products, clients will look to firms like BlackRock to have investments in these product areas.

So I actually believe the turmoil is a long-term positive for us and we are going to be very aggressive, making sure we're well positioned in alternatives with our clients because some clients are continuing to make large investments in alternatives. I think it was announced in the latter part of December that we won a $1 billion assignment from the PBGC [Pension Benefit Guaranty Corporation], and this is all in the alternative space in real estate and fund of funds of private equity. So we are seeing some large scale clients who are still looking to be additive in this space and we believe clients worldwide will do that. And we want to be one of the vendors who are working with our clients.

And touching on the PBGC assignment I think is another good example that clients are looking for complete overall relationships. Clients are looking for partners; they are not looking for product specialists. Clients are looking for partners to help them navigate in different products, whether they are alternative, fixed income, liquidity, equity. But most importantly, clients are looking for a firm that can provide risk management assessments of all the products. And they are looking for a complete relationship. And I think the strong vote of confidence by the PBGC is a very good indication; though, in a hostile environment in alternatives, we are winning some large scale assignments.

Let me just touch on retail, the retail platform. We had positive flows as the retail platform overall in 2008. I think we are going to be one of the only platforms that can say that. Obviously, the fourth quarter was very hostile. We saw over $7 billion of outflows in our global retail platform. But obviously, we had great growth in the first half, some growth in the third quarter and we were able to be in the positive side.

I think that speaks volumes about our products. More importantly, it does identify to the management team of BlackRock to our Board of our success in branding our platform, continuing to build our retail brand globally and importantly, to continue to build our third party channels of distribution. We are very proud of the work we are doing with our distributors. We are spending a great deal of time with our distributors, and as a result of that we believe we are well positioned.

I just have a note of caution about our distributors. As we know, there has been some seismic changes with our distributors. Merrill Lynch is now part of the BofA platform and then we have seen now the Smith Barney platform merging with the Morgan Stanley platform.

Our job is to work with all our distributors in making sure that their platforms and BlackRock's relationships with those platforms are strong. We look forward to working with every one of them. But with these changes in these distribution platforms, it's going to put a lot more pressure in making sure and proving to the world that and to our clients that BlackRock has the skill sets to be working with our clients and we look forward to working with them.

Our institutional business continues to be a prime driver of our business. Fiduciary outsourcing, liability-driven investments, multi-asset strategy, these are the key terms. This is what clients are looking for. Clients are looking for very much of a complete relationship. They are looking for portfolio advice; they are not looking to be just an equity wonk or just a bond wonk. They are looking for an understanding; they are looking for a partnership to work together. And this is how well... this is how we are positioned. This is how we are continuing to making sure we are well positioned to handle our clients' needs.

And I believe having the one BlackRock platform, the one culture on a global basis positions us well to handle those clients needs. So I believe having that platform will allow us to continue to help our clients navigate these hostile markets. And so I look forward to building out our client relationships globally and domestically institutionally.

On our cash and liquidity, we are very proud of our team in the liquidity business. I think 2008 clearly tested every liquidity firm. There are huge survivors and huge losers in 2008. Many firms have announced large either purchases of assets taken out of their funds, huge losses associated with some of their portfolio decisions that they tried to make their clients hold. I would say very loudly, BlackRock navigated our positions very well.

I think our performance in the fourth quarter with asset growth in the fourth quarter, with our liquidity business truly indicated our clients' willingness to work with us. I think the strength of the overall BlackRock platform continued to shine.

In terms of market share, the data that we just received on 2a-7 funds, our market share was... our business was up 20.7%, the industry was up 17.5%. So we were able to pick up market share in 2a-7 funds. If you separate out SEC lending in the third and fourth quarter, you could really see the asset growth in our mutual fund liquidity business. And that was a very strong indication of our growth. We are very excited about the continuation of our liquidity business. We believe it's going to continue to be a large driver of our business. We are continuing to build our third party distribution channels in liquidity in the United States. And we are looking to continue to build our international liquidity business. We believe there is great growth opportunities internationally.

On the other hand, let's be honest: the liquidity business in 2009 is going to be challenged because of low interest rates. And low interest rates are going to put pressure on the liquidity business, at least in the retail business. Institutional business, we are not seeing any pressures to date.

On the positive side, we hope one day clients will start moving money out of liquidity business and go back into long-dated assets, go back into alternatives. And hopefully, as BlackRock's platform allows us to work with our clients, to be that navigator of the asset allocation that we will be a part of their reallocation, whether it's in equities or fixed income if there is a greater stability in our marketplaces.

BlackRock Solutions and advisory, I think everyone somewhat understood our business, but I think people really do not understand how important this business has become to the BlackRock platform.

2007, our revenues was about $195 million. In 2008, the revenues crossed over $400 million. This is a portion of our advisory business that we are doing and the Aladdin business that we are doing.

We are proud to say we had 72 new assignments in 2008, 20 new assignments in the fourth quarter. We completed 46 short-term mandates in helping clients during 2008. We've had expanded equity, expanded Aladdin assignments. We won a new Aladdin assignment already this year and we are working on a number of other large scale Aladdin assignments going forward in 2009. We hope to be rolling out a portion... a part of our Aladdin product is our equity platform. Mid last year, we did buy Impact, which was more of an equity analytics that we are now going to be attaching to the strong analytics we have in terms of fixed income and alternative assets. And so we look forward to building out our platform with our risk management platforms with our clients and provide a more complete service with our clients.

We believe our advisory platform, it's been very visible in the United States working for some official institutions, we have just as much opportunity internationally as official institutions are going to be looking to ring fence, assets ring fence, banks. And we intend to continue to expand our Aladdin and advisory BlackRock Solution platform overseas in 2009. So we look forward to continuing to building that out and we are quite constructive on that platform.

Let me just go into three or four more other points. I know I've been speaking a long time. We have a lot to say. I believe BlackRock's business model is positioned very well for 2009. We will be able to navigate ourselves quite successfully I believe in 2009 working with clients. I am not here to predict what will happen in 2009. Obviously, it started very hostilely, and so much of our business is a window of the market.

So if beta continues to be hostile, it will be a hostile environment for financial institutions including BlackRock. If beta stabilizes and BlackRock continues to build our presence retail institutionally, internationally in the United and here domestically, we will be very well positioned this year.

I am very proud of the branding initiatives we did in 2008. I believe we are very well positioned to pick up more share globally. I believe our branding will continue to grow dramatically here domestically in the United States. I do believe there are going to be huge opportunities in the United States. I think historically, you've heard me talk about more opportunities domestically. But I believe the opportunities will be just as large here as we are seeing a transformation of the financial markets, as we are seeing a transformation in the financial institution arena. I believe we will be a large survivor in this, albeit the marketplace may force us to be smaller, but we will be a large survivor and a big winner in this.

There are very large M&A opportunities for BlackRock in 2009. I promise you, if we do anything, it will be for strategic and product expansion opportunities. But we do see large opportunities in front of us. We've had initial discussions with many different institutions. Obviously, the sea change is so dramatic that the conversations come and go because of the problems associated with different firms. But I do believe, ultimately, we will find something that will be quite additive to this platform. But we're going to be very selective if we end up doing anything.

I would like to just also say two welcomes. We are very excited about the build out of our relationship with Bank of America as they are now a very large strategic partner of BlackRock. We believe this will be a very big business opportunity for BlackRock and Bank of America. We see huge opportunities already. We have been working with the management teams of the old Merrill and the new management teams of Bank of America to try to build products and revenues together. And we see... and we believe, during the course of the year, we will continue to build those opportunities.

It would be wrong for me not to talk about our new administration with President Obama and his economic team. We believe the challenges that confront our economy are severe. We believe there is going to be a great need to firewall assets. I have publicly stated in the past that I believe that TARP should have been used to ring fence and firewall troubled assets. I don't believe putting equity in institutions is the first order of business.

You need to stabilize balance sheets before equity has any virtue. If you don't stabilize assets, money goes into equities, it doesn't help. You can't leverage that equity. So once you stabilize assets and then you infuse equity, that equity then can be used with 10 to 1 leverage and lending will occur.

So I know Congress will be spending a great deal of time asking questions, why aren't people lending? Well, the main reason people aren't lending we've seen as we witnessed in different fourth quarter announcements, extreme destruction in asset quality. You saw that in our non-operating earnings. And so we believe there is a great need for some form of aggregator bank. We believe there is going to be a great need to stabilize balance sheets. And once we stabilize balance sheets, private equity and public equity will be very available to invest in financial institutions. And with that, that new equity will then be used to leverage and to lend.

And so with that, we welcome everyone to 2009. Hopefully, the first few weeks are not an indicator of what we are going to look forward to for the next 50-odd weeks. And with that, we'll open it up for questions.

Question-and-Answer Session

Operator

(operator instructions). And your first question comes from the line of William Katz with Buckingham Research.

William Katz - Buckingham Research

Thank you, good morning. I appreciate the comprehensive update. I do have a couple of questions though, big picture in nature for the most part. Larry, I was wondering if you could talk a little bit about the distribution. I thought you were going to go down this and you didn't sort of flush it out as far as I thought. There has been some significant consolidation, obviously you highlighted Bank of America and Merrill, but we are also seeing it elsewhere, the new joint venture that's about to be unfolded with Morgan Stanley and Salomon, Wachovia, Wells Fargo et cetera.

Laurence Fink

Yes.

William Katz - Buckingham Research

What do you think the implications are for the industry from this historic consolidation? Good, better or indifferent?

Laurence Fink

Well I think one other point that I think we... before we just talk about the consolidation, if anything, we've seen expansion of distributing channels because we've seen the rise of the independent distributor. We're seeing more and more platforms pop up in the independent FA is now a very viable business and platform. And so I would say, obviously, the dynamics are changing. I would say as an industry, I think you are going to see a need to have stronger relationships with fewer distributors... with fewer manufactures. So I believe that this type of consolidation is a very big positive for a firm like BlackRock and other large scale platforms. I think it's very negative for the specialists or small mutual fund platforms. I think that they are going to be choked in terms of providing... in terms of the distribution channels. The distribution channels will probably extract more leverage. They are going to probably try to extract more fees. But I believe the large scale platforms will... manufactures are going to be the net beneficiaries of that.

With some of the names without getting into the details, we saw in one of the cases, one of those third party distribution channels away from the Merrill BofA, we went to I believe the number one net sales with one of those third party distributors. And I think we are now ranked third, maybe even second in terms of net sales with one of those aggregators of... one of those firms that are combining. So we see this as a real positive. We see these firms are going to be looking for a more complete relationship and are looking... they are looking for more partnerships, relationship. They are going to become more institutional with the gatekeepers. And so I think we'll be a beneficiary of that consolidation.

As I said, I think in the third quarter, and I didn't mention it this time, we have, despite our downsizing in personnel, we have... one of our big growth areas is to continue to expand our distribution platform with third party distributors. So we planning to be hiring their despite obviously the consolidation of these three platforms. But we believe the role of the independent distribution platform is going to grow and we need to be spending more time with those platforms.

William Katz - Buckingham Research

Okay, that's terrific. Second question I have is just coming back to the cash management business for a moment. It seems like this is an industry... probably an industry that's poised for significant consolidation. Some recent press out there suggesting that, I think a study by the G30 that the cash management business should have some kind of capital allocation against it.

Laurence Fink

Yes.

William Katz - Buckingham Research

Sort of wondering what you view is on that and how that might influence your participating in that part of the business.

Laurence Fink

We are a loud and large believer that capital should be... capital charges or the ability to reserve is a very important component. So we are probably louder than most of the players in this business on that. I don't believe the ICI has that position; I believe they are against that position. We are very much in favor of that position. We have been asking our auditors, can we reserve one or two basis points on our money management liquidity business for years. And we were not allowed to because obviously auditors don't allow you to do any reserving. But we believe by having some type of government oversight with the idea that we are having capital reserves is a very, very important component for the future of money market funds.

I believe as your investors know, there is capital behind those funds, it gives more stability to the business. I believe that challenge in 08 were why should I have money with money market funds when I can go to a bank and the bank as FDIC guaranteed? To me that's a bigger challenge for the long-term survival of money market business. And so we believe the money market business, which is essentially a shadow banking business, should be treated like a banking business with capital charges associated with it, or reserves associated with it. We believe it's going to fore spill even a greater consolidation in the money market business. And obviously for the small firms that do not have the scale, the added capital charges or the reserving for capital it's just going to force down profitability even more and is going to make it a more of a scale business than ever before. So we are in favor of it.

William Katz - Buckingham Research

And so two other final questions. Wondering if you could quantify the savings from the head count reduction and where those reductions came from. And then Ann Marie, if you could just sort of flush out the FX impact on both revenues and expenses this quarter, one more level if you don't mind.

Ann Petach

Okay, on the head count, I think you can estimate it fairly easily by just taking 500 people times of fully comp personnel, a person that would be on average right (ph) for a full sized firm. So that I think you can get at very easily.

As far as the FX, I would just differentiate between two things. One, the FX that I mentioned with respect to G&A is the balance sheet-related FX. I think what you are asking about is FX related to revenues and related to expenses where we do have some balance in that we do have euro and sterling revenues, but we also have very significant sterling-based costs. So we do have a positive margin business, but on the other hand, we do have costs, very material costs in same places where we have very material revenue.

William Katz - Buckingham Research

Okay. Thank you.

Operator

Your next question comes from the line of Roger Freeman with Barclays Capital.

Roger Freeman - Barclays Capital

Hi, good morning.

Laurence Fink

Hey Roger.

Roger Freeman - Barclays Capital

Hi. I guess I have a question on the advisory base fees. They take down a fair amount sequentially, and it looks like equity and balanced was hit the hardest. Is that a function of mix? Is it less equities inside of equity and balanced and how do... or is there anything unusual there? Is that sort of the run rate to think about going forward?

Laurence Fink

Roger, when you talk about advisor, you are not talking about the BlackRock Solutions advisor --

Roger Freeman - Barclays Capital

No, I am talking about across your (inaudible)

Ann Petach

Yeah, that was predominantly just driven by the fact that markets hit equity and balanced the most. So really --

Roger Freeman - Barclays Capital

Okay.

Ann Petach

What I said is in my comments was really base fees represents the bulk of the equity decline. And within that, 80% to 90% of it, in one case over 90% depending on periods you're comparing to, is related to equities and balanced.

Laurence Fink

Yes, and I said, in the fourth quarter, we did see in the retail platforms, outflows in equities, but --

Roger Freeman - Barclays Capital

I was just --

Laurence Fink

The market was so dominant, and I would also say, we did have positive alpha, so it was just dominated by beta.

Roger Freeman - Barclays Capital

Right. But I guess I was asking in terms of the basis points, right, the 33.4 basis points in aggregate from 3Q going to 28.7. I think you answered it. It does sounds like it's mix, less equities in there, which means --

Laurence Fink

Yes, that's all it is. Yes, you answered it.

Roger Freeman - Barclays Capital

Okay. And then on comp, and just to sort of come back, I think you partially answered the question previously. But if we were to look at, I am assuming part of the downtick in the comp-to-revenue is a reversal of prior accruals, maybe bonus accruals. I mean how would you think about a fair comp-to-revenue ratio for the 4Q, adjusting from any reversals previously?

Ann Petach

Well, I looked at the data and I think one thing you can do is look at the full year comp-to-revenue ratio and think about that.

Roger Freeman - Barclays Capital

So that was actually good... I mean it actually was down sequentially, which is sort of surprising given the decline in AUM.

Ann Petach

Comp-to-revenue about 5%, about flat to a year ago. And rather than look just at the fourth quarter, I would look at the full year.

Laurence Fink

As a guide post, there is no question the first half, Roger, we had some large performance fees that were --

Roger Freeman - Barclays Capital

Right.

Laurence Fink

So it's been skewed a lot in terms of the destruction of assets, especially in some of the areas where there are some large performance fees in the first half that were totally wiped out in the second half.

Roger Freeman - Barclays Capital

So you adjusted your human resource base in the 4Q, markets are down another 10% here. Going into the year, I mean you said you are going to proactively continue to cut costs. I mean are you basked appropriately for where we are at right now?

Laurence Fink

We analyze that all the time. There is... at the moment, there are no plans.

Roger Freeman - Barclays Capital

Okay.

Laurence Fink

We are... but I don't want to mislead anybody to say that this is not a dynamic situation that we all have to look at. And I will say we also have strategic opportunities from the BlackRock Solutions area, our retail distribution area; we are going to continue to grow.

Roger Freeman - Barclays Capital

Right.

Laurence Fink

I would not suggest that we would not do staff reductions if we needed to if the market continues to erode. But I will say loud and clear, we are not anticipating any at this moment, and there is no plans for it at this moment.

Roger Freeman - Barclays Capital

Got it, okay. And then on the advisory inflows, that $100 billion or so in the fourth quarter, I mean I know you've been hesitant to talk about fee structures tied to that, but now it's obviously getting to be more significant. And so if we think about the comments you've made, which is they are a largest assignment, they are fixed income in nature, they are complex, does that mean that they are around, and when you bake that all in, around what a fixed income capture rate is or a little bit higher?

Laurence Fink

No, they are actually lower.

Roger Freeman - Barclays Capital

They are lower. So lower than the sort of 17, 18 basis points?

Laurence Fink

I won't go into that because some of the assignments are official institutions where we cannot discuss it, and they are lower, but I will say they're profitable and they are very important for this platform. And obviously, by looking at the delta of broker revenues, it's significant in the solutions space. And so it's a significant component of our growth and will be a significant component of our growth in 09.

Roger Freeman - Barclays Capital

Okay. And last thing, Larry, just macro, do you think... I don't know if you made public comments on this, do you think cram-down legislation is an appropriate course of action? Will it be effective? Wilbur Ross is actually on the tape while we are on this call saying that he thinks mortgages should just be reset at 100% of current home prices. Does that make sense to you?

Laurence Fink

Here is the situation. I mean there is a lot to be said about in the subprime space if we need to keep people in their homes and there needs to be a reappraisal of the valuations. In some of the mortgage space, you have assets trading at $0.20 and $0.30 and yet the default of the moment are only running at 20%, and so you have a huge difference. So you have a lot of room to revalue the asset. And so maybe the mortgages now were $0.50, there is still a gain in the subprime space. So there are many areas where resetting the principal amount of a mortgage is very doable and it will... and no, there is not a real loser in the whole situation.

The situation that we are saying loudly to our government, loudly to our new economic team is that if we force cram down with assets that are trading more closely to par and we harm the security holders, the foreigners who own tens of billions of dollars of our mortgages, who believe they are going to get par back and the mortgages are crammed down, we will disrupt capital demand for our mortgage business for a long time. And so what we are telling our government, do not in the sake of helping home owners, harm our investors. You're going to have to change security law in the Grantor Trust in many ways. And so this has to be done cooperatively with the security industry, with government, with the mortgage industry.

But cram down overall... and we're talking about cramming down everything, that would have some severe impact in our global capital markets. And I would hasten to say that we will have a hard time finding buyers of our mortgage credit in the future. So this is a very delicate situation and it should be done cooperatively with the security industry, with the groups that are representing security holders to do it properly. So it is not a clear and cut answer. But overall if we are talking about cram down in the entire mortgage industry, I would say that would cause much greater long-term havoc and damage than what we are experiencing now.

Roger Freeman - Barclays Capital

Right, thanks for your thoughts.

Operator

Your next question comes from the line of Michael Carrier with UBS.

Laurence Fink

Hello Michael.

Mike Carrier - UBS

Hi. Thanks. Just first one question and a follow up on the fee rate. I understand the negative mix in assets pressuring the overall fee rate. But if I just look at the equity assets and the equity fees, the rate on the equity assets seem to come down significantly in the quarter sequentially. So I was just wondering if there was some sort of shift in there in terms of more equity versus balanced, retail versus institutional or if there were any fee cuts in there.

Laurence Fink

Well, no. A, there were no fee cuts, it was the mix we saw more outflows and more beta declines in some of our European equity products, especially our energy products which were much higher fees. And that's just... as you know what has happened to the energy sector. So that was probably some of the highest fee products and that was where we saw in the third and fourth quarter the greatest declines in NAVs. And so it's really a mix within equities, there are no fee changes or fee waivers. It is just the mix going into... going out of some of the more specialized equity products into the more core equity products and that's all you are seeing. There was... the dynamics are nothing but that.

Mike Carrier - UBS

Okay. And then just on the non-operating income, in terms of the investment portfolio and losses, can you give any more color, and I think this is more just looking forward to try to gauge the portfolio and the losses, whether it's the first quarter or throughout 09, just in terms of the relative buckets of the assets. I know you guys did the breakdown in terms of hits during the quarter.

And then I guess, just overall, if the portfolio is down about 25%, and granted, depending on the market, markets could be down anywhere from 10 to all the way up to 50%. But just trying to get a sense of some of the relative levels of where these valuations are, whether it's in private equity or real estate or distressed.

And then the final one is when you do look at valuing these assets, for any of them that you're getting from say fund of funds or third party providers, is there any way to kind of do evaluation checks on what they are giving you just so it's in --

Laurence Fink

Yes, well, I'll let Ann Marie answer the core question, but we have third party providers go in all our fund of funds advisory assignments. So we are not taking... there is no question, we are not taking the manager valuations. We are going in and getting a third party appraiser. And I think that's probably industry standard, that's not unusual.

Ann Petach

Yes, I would say on first question, the first question with the distribution of the portfolio, the last time we talked about this, we said we mentioned five asset classes being the more public markets, distressed credit, hedge funds and fund of funds and private equity and real estate and that each of those represented between 15% and 25% of the total portfolio. That distribution of our investments remains the same even with the marks. So the portfolio in proportion... now it may have moved within those ranges, but still remains about there. As far as the marks go, we don't rely solely on broker quotes or anything. We look through to the assets, we look through to the cash flows to make sure we understand. We do have the duty to make sure we're looking at those as appropriate hiring outside mangers. And I am sorry, what's the other one?

Laurence Fink

I think you should talk offline with Mike. We really have a few more... about 10 more minutes, so we have many more questions.

Mike Carrier - UBS

Okay, that's good. Thanks a lot guys.

Laurence Fink

Thanks Mike.

Operator

Your next question comes from the line of Roger Smith with Fox-Pitt Kelton.

Laurence Fink

Hi, Roger.

Roger Smith - Fox-Pitt Kelton

How are you doing? Thanks a lot. And I just want to talk more on the institutional side, and I know you talked about your clients looking for one provider. I just want to try and understand when you are out there talking to them, what should we be thinking about in terms of their target allocations? I know you said there will be balancing. And then really how does the role that you guys are going to play kind of change with the consultants and what would the consultants role sort of be on a go forward basis?

Laurence Fink

Let me go over allocations. I mean it really depends on the client... the clients, their liabilities. If a client has assets that are substantially lower than their liabilities, they are probably going to be reallocating out of fixed income more into equities. If clients are imbalanced because of liquidity issues, they're probably allocating out of alternative as best as they can into more liquid assets. If clients are just totally frightened, they are allocating all long-dated assets into cash. We are trying to recommend clients to shy away from cash as much as possible to start reinvesting. And so it really... we take an asset and liability approach to all our clients. There is not one formula. It really depends on the clients' needs, their cash flow needs, the timing needs. And so... but I think it's fair to say clients overall are looking for more stable returns. They're willing to accept much lower returns now for more stable returns. So I think that's a generalized theme, and so there is not one formula.

And in terms of our relationship with consultants and consultants are still a large driver of our business, consultants are actually also getting into the asset management business as they play a role as an asset allocator and we are too. So in a lot of ways, we are playing some role as a consultant with some clients and some clients, we are working alongside with consultants in terms of working on asset allocation. There is not one right model, but our service, the opportunities are being blurred between the BlackRock platform and some consultants. But the clients are... I mean the consultants are a very large component of our client business. We work with them, we try to make their business better.

We are not trying to take away business from consultants, but we are just trying to be a larger partner with our clients, our direct clients. And in those cases when they are looking for more of a fiduciary relationship, we are taking on those responsibilities. Fiduciary outsourcing is growing much larger in Europe, and this is where we want a large amount of fiduciary mandates in Europe. And in Europe, this is where the consultant community had a less of a historical role.

And then you have, I would say, the partnership type of relationships we have such as PBGC, which I mentioned, a consultant played a role in that. A consultant was very active working with the client and we acted as a partner working alongside with the consultant and the client. So once again there is not a real model.

Roger Smith - Fox-Pitt Kelton

Okay, great. And then really on the advisory business, I know with these assets that you are getting, and I know you don't want to talk too much about the fee pressure. But what are these expectations of the client in terms of the duration of some of these mandates? Is this something that a lot of them are thinking might be a 12 to 18 month deal or is this something that we can end up seeing stay for 5 years or 10 years or more?

Laurence Fink

I think it's probably more appropriate to think 5 to 10 years. I think if the assignment is done with some official institution, the main purpose is to stabilize the assets, work out the assets but most importantly, not disrupt the marketplace. And so if you told me in two years the market is going to be totally fine, and it's going to be able to handle more supply and more opportunities, then it's a shorter term assignment. I think our expectations that it is much larger than two years or 18 months I think our expectation is north of five years. But it really depends on the global economy and the global capital markets.

Roger Smith - Fox-Pitt Kelton

No, that's good. And then just the last question is on Quellos with the pressure in the fund of funds business. How is that really playing in this total product that you are offering and do you see fee pressures? And even with... you're seeing a lot of funds cutting their fees, is that pressuring the other managers or do you not see as much of that happening?

Laurence Fink

No, once again, I mean I think the Quellos product, which we don't call it Quellos anymore, the BofA product.

Roger Smith - Fox-Pitt Kelton

Right.

Laurence Fink

That was part of like the PBGC. So there was a good example of cross selling products, so it was a real estate product, then a fund of funds product. And so it really depends on the product, but we are not seeing fee pressure. We are seeing people question the whole alternative space as they suggested. And I think this is an industry problem, and yet I do believe there is a greater role for high quality fund of funds platforms that do the due diligence that have the systems of risk monitoring.

Unfortunately, there are many fund of funds platforms that were a big allocator of Madoff. And so it puts a black eye in the entire industry. Where were their risk management tools? Where were their alarms when the institution played every role from custodian and everything else in terms of assets? To me, there were just some big open questions that really throw the whole question of the virtue and value of fund of funds with some people. I believe overall, it's going to play a much... there is a active role for fund of funds. I believe if a platform like BlackRock with a risk technology and having the BAA base a (ph) part of overall platform will play well for those who are still believers in the fund of funds space.

Roger Smith - Fox-Pitt Kelton

Great, thanks a lot.

Operator

Your next question comes from the line of Robert Lee with KBW.

Laurence Fink

Hey, Rob. Sounds like he dropped off.

Operator

Robert, your line is open, please go ahead.

Laurence Fink

Let's move on please because it's getting late.

Operator

Okay, the next question will come from the line of Craig Siegenthaler with Credit Suisse.

Laurence Fink

Hey Craig.

Craig Siegenthaler - Credit Suisse

There has been a lot of discussion in this industry to how it's really going to evolve. And I guess one demand we are seeing in your result is stronger demand for advisory business. But I guess history would tell us that there should be some decent pent-up demand for some institutional equity products too. And I'm just wondering in your view, is it that advisory, asset liability, other fixed income, cash management should continue to take share here even in the case of rebounding markets? Or is this really just a function of higher risk premiums? Is that really why we are still seeing large demand for fixed income products?

Laurence Fink

Don't have a complete answer to that. I believe at this moment, there is a view that until fixed income credit stabilizes and narrows, it's very difficult to think equity products can go that far. So I believe the first order of business, we need to see a big rally in a lot of the credit products. We need to see stability in a lot of the credit products and then we'll see equity products rebound very strongly.

It is our view that we are going to see some time in the future that stability. But we do believe the equity markets will respond much quicker than people... than most people believe in by just looking at how much money is in cash and that money will rush into equities much faster than people think once we see the stabilities in the credit markets.

And so we are recommending the clients to add to their equity allocations, but pay attention to liquidity this time. I actually think if you look at the mutual fund flows, we saw huge historical outflows in the Large Cap Series of products industry wide as people started to navigate into different specialized products and navigate into alternative products. I actually believe we can see for the first time in maybe a 10-year cycle a large flow back into Large Cap Series types of products, be it value or growth or core.

As people are going to value liquidity a lot greater and value large cap products, which provides probably the most complete liquidity of all to alternative and equity products, so, in products like Global Allocation. So we believe we're going to see that, as I noted, we are starting to see more and more inquiry. And we've had in our pipeline a couple of large wins in the last few days. So we are starting to see client activities pick up.

But on the other hand, I think clients are going through their whole asset and liability review now over the next 4 to 10 weeks. And I think you're going to see some real large allocations. We would recommend the clients to go heavily into credit and go into equities. We believe unless you are frightened of the world, you should not be in treasuries.

Craig Siegenthaler - Credit Suisse

Got it. I mean I think, well my question was really trying to get at is the potential persistency of your advisory and your cash management business should the markets rebound here --

Laurence Fink

Cash management, I expect cash management to fall. And if markets rebound dramatically, I believe the whole industry assets will fall. Hopefully, we will continue to pick up share, but we expect... yes, we certainly expect that assets will fall in liquidity.

On the advisory business, actually, I believe 09, maybe 2010 is going to be very large opportunity for us. I believe there are going to be large scale needs to stabilize financial institutions globally. I believe we will have some great opportunities to work with these institutions. I believe there is a global appreciation to risk management and I believe our Aladdin platform will be a very large growth part of our future business. And as I said, I believe that the advise part of our Advisory business will be... will grow dramatically Even if there is stability in assets, as you suggested there may be.

Craig Siegenthaler - Credit Suisse

Got it. And just a quick one for Ann Marie. When you look at comp expense, there is kind of... my view is two large unusuals in the quarter, one from deferred comp and one from severance. If you take them out and think about how comps should trend in the next year, is that a core number? Is there additional expense reductions that we haven't seen really play out in the fourth quarter yet?

Ann Petach

I think when you think about the fourth quarter, you are correctly adjusting for the comp, and we have given you that detail. The comp-related hedge stuff. So you take that out. I think that you think about the full year comp-to-revenue ratio, which you need to factor in and then really as far as the head count reductions, that really didn't come into play till probably the beginning of December. So it's a partial quarter effect of that.

Craig Siegenthaler - Credit Suisse

Got it. Great. Thanks a lot for the color.

Laurence Fink

Operator, one more question please and we're going to call it.

Operator

Okay. The next question should come from the line of Robert Lee with KBW.

Robert Lee - Keefe, Bruyette & Woods

Thanks. Hopefully, it works now.

Laurence Fink

How are you?

Robert Lee - Keefe, Bruyette & Woods

Good. How are you doing? Just really two quick questions, the first relates to the MBS purchase program, understanding... talking about the fee structure. But is it... assuming the program hits its target of upwards of 500 billion of purchases in the first half of the year, should we expect that it's going to be about 100 billion of thereabouts of flows in that program?

Laurence Fink

We don't include that in our... we need not include that in our flows, that program, and I don't believe we will because I don't believe it's proper for us to describe what's going on. We will let the clients announce that specific program. So we're trying to be as opaque on that as we feasibly can. I can't even talk about it. I mean that's a program that I'll allow the client to do their official release and discuss it.

Robert Lee - Keefe, Bruyette & Woods

Well maybe just from the geography on the financials perspective, is that going to show up in fixed income assets or advisory assets?

Laurence Fink

As I said, I don't... we are not certain whether we're going to show those as assets. We are... the revenues will show... we'll show revenues in advisory, but I don't believe that specific program... we have not determined whether we will show that even in the assets.

Robert Lee - Keefe, Bruyette & Woods

Okay. And --

Laurence Fink

Because it's so skewing and so... it could be so large.

Robert Lee - Keefe, Bruyette & Woods

Okay. Just a quick question on the balance sheet, Ann Marie, maybe just get a quick update or maybe a snapshot what it looks likes now in terms of sort of free cash if there was any kind of debt reduction in the quarter. Just trying to get a sense of what kind of the net cash position looks like.

Ann Petach

Yes, we continue to be a positive cash flow business. We of course haven't published the balance sheet yet, but there were no really changes in our debt position. We neither took on more debt nor did we prepay any debt. So you're going to see a pretty stable balance sheet. The one thing I would remind you of, which is an annual event is that year-end cash does tend to be higher than the end of first quarter cash because of incentive comp and the timing of that payment.

Robert Lee - Keefe, Bruyette & Woods

Okay, that was it. Thank you very much.

Operator

And ladies and gentlemen, we've reached the end of the allotted time for questions. Mr. Fink and Ms. Petach, are there any closing remarks?

Laurence Fink

Thank you for taking the time. It's been a long conference call. We look forward to talking to everybody at the end of this first quarter. Thank you. Have a good day.

Operator

This concludes today's teleconference. You may now disconnect.

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