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Executives

Meg Gupton – Corporate Communications Coordinator

Donald W. Hultgren – President and Chief Executive Officer

Kenneth R. Hanks – Chief Financial Officer

John L. Holt Jr – President and Chief Executive Officer, Southwest Securities, FSB

Analysts

Hugh Miller – Sidoti & Co, LLC

Edward Hemmelgarn – Shaker Investments

Joel Jeffrey – Keefe Bruyette & Woods

Chuck Griege – Blue Lion Capital

SWS Group Inc. (SWS) F2Q09 (Qtr End 12/31/08) Earnings Call February 5, 2009 2:30 AM ET

Operator

Good morning and thank you for standing by. At this time, all participants are in a listen-only-mode after the presentation we will conduct a question-and-answer session. (Operator instructions) I would now like to turn the call over to your host Ms. Meg Gupton. Ma’am you may begin.

Meg Gupton

Good morning and welcome to the SWS Group First Quarterly Conference Call and Webcast. This is Meg Gupton I’m the SWS Corporate Communications staff. We are pleased to join us today.

The quarterly earnings press release can be found on our website at swsgroupinc.com or on the Yahoo Finance website under SWS news. Market professionals on our distribution list should also have received the slides for today’s call via e-mail. If you would like to be added to our e-mail list to receive press releases or to be notified of future quarterly calls, please contact us at 214-859-6351.

This conference call is being webcast live on the Internet along with the accompanying slides at swsgroupinc.com where it will be archived for the next 30 days. (Operator instructions) Those participating via the Interent can ask questions from the link provided in the webcast page or by e-mailing them questions at swst.com

This presentation contains forward-looking statements. You are cautioned that any forward-looking statements, including those predicting or forecasting future events or results which depend on future events for their accuracy, and by the projections or assumptions, words express the intent, belief, or current expectations of the company or management, are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially as a result of various factors, some of which are out of our control, including, but not limited to, volume of trading and securities, volatility of securities, prices, and interest rates, availability of lines of credit, customer margin loan activity, creditworthiness of our correspondents and customers, demand for housing and other factors described in our annual report on Form 10-K and in our other reports filed with and available from the Securities and Exchange Commission.

At this point, it is my pleasure to introduce Mr. Don Hultgren, Chief Executive Officer of SWS. Don?

Donald W. Hultgren

Thank you, Meg and good morning everyone. Thank you for joining us on the call this morning. I’d like to start off by introducing the other participants on the call. With me are Ken Hanks, who is the CFO of SWS Group, the parent company. Also John Holt, who is the President and CEO of Southwest Securities, FSB, our bank; and Jim Ross, President and CEO of Southwest Securities and SWS Financial, the brokerage arm of our business.

Our agenda today is as follows. I’ll provide an overview of the second quarter of 2009, review some noteworthy items, and touch on some important events since our last conference call. Ken Hanks will then provide a more detailed review of the second quarter. John Holt will provide an update on the activities at the bank. I will then discuss our market position and our three primary growth initiatives. And finally we’ll open it up for questions.

And again if you have questions it’s * 1 on your telephone or you can also submit them by e-mail to questions@swst.com.

Net revenue in the quarter increased from $73 million in last year’s second quarter to $100 million in this quarter. Income from continuing operations increased from $7.2 million in last year’s second quarter to $9 million in this year’s second quarter. And earnings per share in the second quarter increased from $0.26 last year to $0.33 this year. Finally we ended the quarter with a book value per share of $12.21.

Turning to noteworthy items in the quarter, this was an especially strong quarter for our institutional fixed income business. We saw our taxable group grow its commissions by 280%, compared to the second quarter of last year and we also saw very good growth in our tax free-commission, which were up 97%, compared to the same period last year.

In the quarter, we added to our loan loss allowance at the Bank. We added in that $1.4 million to the allowance compared to $630,000 in the September quarter and 465,000 in the same quarter of last year. Cuts in the Federal reserve rate have a short-term negative effect on our interest rates spread at the Bank. This is because most of our loans are priced that is spread over prime or LIBORas As rates fall, the loans reprice immediately while there is a lag in the rate adjustment or deposits. The Fed did cut its rates this quarter. As a result, the Bank yield on interest earning assets was 4.39% in the December quarter, which was down from 4.52% in the September quarter. Obviously, this is different in a rising rate environment, the impact will be positive.

Turning to important events since our last call. We completed the conversion of the accounts of M.L. Stern, the Southwest Technology platform on December 15. The broker-dealer withdrawal paperwork was filed with FINRA this week. And the assimilation of policies and procedures is still underway.

Based with the challenging environment, the Bank has reduced its headcount by 9%. We believe this will result in annual savings at the Bank of about $1.2 million on a pre-tax basis. We have made a decision not to pursue the TARP funding. It’s our opinion that we can keep the Bank well capitalized without the risk and uncertainties of the terms for accepting the government money.

And finally in recent quarters, the firm held a significant investment in auction rate municipal bonds. Our knowledge of the credits and the uncertainty of that market, allowed us to make a substantial return on the investments. The returns in that market have declined, and we have reduced our exposure accordingly.

Our investment today is down $70 million from where it was at the end of the first fiscal quarter, and our investment today stands at about $25 million.

Right now let me turn it over to Ken to go into more detail on the second quarter results. Ken?

Kenneth R. Hanks

Thanks Don. Good morning everyone, even though Don as already highlighted the exceptional performance of our fixed income businesses, I want to say that I have been amazed that the strength of the sales related income from both municipal and taxable debt. These surging markets have benefitted our customers, our employees and our shareholders.

Next I would like to spend a few moments discussing quarterly summary financial results, then move on to a more detailed discussion of our operating results and conclude by the discussing in our segment information.

First on the income statement. Net revenues for the quarter, that is operating revenues plus interest revenues, less interest expense, were up by $27.4 million or 38% for the quarter, while pre-tax earnings were up by $3.7 million or 31%. The M.L. Stern division of Southwest Securities contributed net revenue of $12.8 million and expenses of $10.3 million for a pre-tax profit of $2.5 million for the quarter.

There were no amounts for the M.L. Stern division last year as the acquisition did not closed until April 1st. Turning to a review of our individual operating cost. Net revenues from clearing is next. Our net revenues from clearing were down 18% for the quarter. In the quarter we processed $2.3 million trays down from $8 million in the same quarter a year ago.

Day trading tickets were the primary driver of the decline in tickets as the full impact of the loss of one correspondent was reflected in the fourth quarter numbers. On the other hand revenue per ticket was up in the December 2008 quarter and was $1.36 versus $0.47 per ticket in the same quarter last year. This change is primarily attributed to the reduced volume from day traders in the current quarter over last year.

Commissions were up $27.2 million or 104% in the quarter with $9.3 million of the increase coming from M.L. Stern while our other retail operations showed a slight decline of $1.7 million. As previously mentioned the taxable our municipal fixed income businesses had extraordinary performance with commissions surging at $19.9 million versus last year’s quarter.

Investment banking and advisory fees were up 7% in the quarter. Fees of $1.4 million from M.L. Stern were offset by reduced fees from corporate finance transactions and public finance transactions.

Net gains on principal transactions, which are derived principally from trading in fixed income securities, were up $5.4 million in the second quarter, as compared to the second quarter of last year. Taxable trading contributed $2.2 million of the increase, while municipal trading was up $1.6 million. M.L. Stern was the last major component of the increase.

In our press release, we attributed some of our success to increasing rates on treasury. This was not a correct statement. The majority of our successes in taxable was due to profit from trading corporate bonds. Other revenue is down $6 million for the quarter primarily due to losses recorded on our venture capital fund investments, as well as reduced values of the assets in our deferred compensation plan.

Net interest revenue, which is interest revenue less interest expense of $26.4 million, was up 3% from last year’s quarter. The Bank’s net interest was up 20%, while net interest at the brokerage was down 13%.

The decrease in brokerage net interest was driven by reduced spreads on customer funds on deposits as the rates we earn on our reserve account assets has dropped to near zero. This decline was offset by earrings from auction rate bonds, which provided the increased municipal bond interest of $1.4 million. We carried an average of $65.1 million of these securities during the second quarter and currently carry approximately $24.5 million of the bonds. Net interest at the Bank was up due to higher average loan balances.

Average margin balances in the customer side of the brokerage business of $181 million are down 22% from the previous quarter and down 38% from the same quarter last year due to market activity. Credit balances are down 13% from September and 18% from December of last year. Stock loan balances are down 38% from September and 43% from last year. While stock loan balance have seen a significant decline since last year, spreads continue to hold up and we are ahead of last year’s quarter about 74 basis points.

The balance decline has come from reduced willingness; the balance decline of stock loan has come from reduced willingness of institutional holders to longer securities reduced market volumes and internal credit reduction. Average gross loans at the bank were up 3% over the September quarter and up 25% over the prior year. The contraction in our construction loans portfolio has been more than offset by growth in commercial loans.

Turning now to operating expenses. Operating expenses were up $24 million from the prior year's quarter. M.L. Stern accounts for $10.3 million of this increase. Compensation expense was up $20.2 million, with $7.8 million related to Stern and the remainder related to increased commission expense in the fixed income area as well as increased headcount at the Bank.

All other categories of operating expenses were up a total of $3.5 million Stern accounted for $2.6 million of this increase, while the cost of servicing OREO at the bank, as well increased wins from new locations in our retail division accounted for an additional $1.0 million.

Increases in travel, legal, and other expenses account for the remainder of the change. This slide presents operating results by segments for the second quarter. Our first segment is Clearing. This business encompasses our share of all the fee revenue collected from our correspondents and their customers as well as the net interest earned on correspondent and correspondent customer accounts.

For the second quarter, this segment earned $1.9 million, down from $2.7 million last year. Clearing fees were impacted by reduced fees from day trading clients as the previously announced departure of one client completed during the quarter. Additionally, other day trading customers recorded substantially reduced volume. Compressed interest spread and reduced customer margin balances have continued to reduce allocated interest in this segment and reductions in operating expenses have not been enough to offset these declines.

The Retail segment encompasses our Private Client Group as well as our independent contractor/brokers that are housed in SWS Financial Services, along with our M.L. Stern business. This segment also includes the product lines that directly support these sales forces.

As we indicated previously, M.L. Stern contributed $12.8million in net revenue and $2.5 million of pretax income in this segment. Excluding Stern, Retail segment net revenues were down 18%. Declines were posted both in commission revenues and in allocated interest revenues as spreads continues to decline. Pretax contribution from our independent contractor business was down approximately $800,000 from reduced revenue, while the Private Client Group contribution was down about $1.4 million, from reduced net interest revenue and increased expenses from new offices.

The Institutional segment consists of our brokerage businesses that service institutional customers, including fixed income sales and trading, public finance and corporate finance, equity and portfolio trading, as well as stock loans. Pretax for this segment was up 94% for the quarter and the fixed income trading businesses showed dramatic increases, offsetting reduced contribution from the investment banking business. Both taxable and municipal units improved dramatically, as volatility helped increase volume. We kept taxable inventories light and continued to reduce our investment in municipal auction rate bonds.

Stock loan results were down slightly from the prior year, as market conditions and internal risk management tactics reduced balances. The equity side of the institutional business was up 22% over last year as reduced expenses contributed higher pretax profit. The Banking segment produced net revenues gain of 13%; however, a $1.7 million addition for the provision for loan losses increased REO expenses as well as compensation from increased headcount over last year caused a 34% increase in operating expenses in the second quarter.

Subsequent to the quarter end, the Bank made some personnel changes that should reduce operating expenses going forward. John Holt the CEO of the Bank will provide additional color on the banking environment a little later in the call.

The Other segment includes corporate investments as well as the unallocated corporate administration expenses. This is where we record the results of our venture capital investments, as well as the administrative cost of accounting, legal, and other corporate shared services. Primary changes this year over last, include a write-down of $2.5 million in the value of corporate investments as well as losses in the value of our deferred compensation plan investment and additional compensation plan.

Lastly, I would like to turn, lastly I would like to discuss the few operating statistics for the quarter.

Tickets processed decreased 71% from last year's quarter, while dropping 59% over September. Activity from day trading customers is a primary driver of these changes. PCG rep cuts is up significantly from last year and includes 104 reps from Stern.

We are also selectively hiring in the institutional area as other firms close down businesses that we believe, will be profitable for us. The total employee headcount increases includes over 200 from Stern with the rest mainly in the banking area.

I would like to mention that the drop in day trading figures in the customers that left was a customer that was purchased by another large broker-dealer. Our next slide presents average loan, deposit and capital balances at the Bank. We also highlight the amount of deposits provided to the bank by brokerage customers, which averaged $943 million in the second quarter versus $780 million last year. Our reserve to loan ratio is up to 84 basis points, while our percentage of non-performing loans to total assets was up to 3.09% from 2.5% in the September quarter.

Net charge-offs of $410,000 were up slightly versus the September quarter and we expect to see this numbers grow in future quarters. As non-performing loans move to the foreclosure status, we require updated appraisals and estimates of selling costs on the properties. This determines the charge-off amount that reduces our loan loss allowance.

At the end of the period, we update our loan loss allowance compensation to determine the amount needed to safe the reserve at an appropriate level, which is what generates the loan loss provision that hits the income statement. As mentioned earlier, in the December 2008 quarter, the provision for loan loss allowance was $1.8 million.

Our net yield on earning assets decreased 13 basis points since September, but should improve over the next quarters, as the latest Fed rate reduction is absorbed and interest rates floors in our loan agreements are activated.

I would now like to turn the presentation over to John Holt, the CEO of Southwest Securities, FSB, our banking subsidiary.

John L. Holt Jr

Thanks Ken. Along with updating our listeners on the bank's three primary lines of business, I will give insight into our consideration of the Treasury’s Capital Purchase Program. We spend significant resources during the quarter analyzing the government’s TARP programs and have decided not seek funds through capital purchase program. The primary reason with the uncertain regulatory requirement and the unilateral structure of the terms and those were the real key concerns that we have in accessing that. The Bank will remain in a well capitalized position with would include a capital injection from our parents during the current quarter. Additionally we expect the firm’s business and its earnings will provide the necessary capital for us going forward. Despite the severe headwinds that exist in the current economic climate the banking segment had another profitable quarter with $2.36 million in pre-tax income. We saw another quarter of loan growth and expansion, on a linked quarter basis we grew our average loans outstanding 3% and approximately 25% year-over-year.

Our modelling growth strategy of building the bank around the banker continues to drop loan growth primarily in commercial bank. During the quarter we converted the El Paso loan production office to a full-service banking centers, which brings us to 13 full-service banking centers and two loan production offices. We have experienced an increase in non-performing assets of $44 million or 3.1% total assets. Non-performing assets were primarily comprised of residential real estate representing 53% total NPA’s and commercial real estate representing 44%.

Our C&I portfolio is holding up with non-performing assets remaining low at less than 3% of the total. The continued downturn in general economic conditions is now causing deterioration in our Banks commercial real estate portfolio. While we still do not anticipate a recovery of the real estate market in the near-term we believe we are appropriately reserved at this time as we increase the allowance for loan losses up $1.4 million for the quarter. We continued to focus on credit quality initiatives in our residential construction portfolio and will reduce exposure to this portfolio as it runs off.

Mortgage purchase lending ended the quarter with average loans outstanding of $222 million with fundings in excess of $1.55 billion or 8300 files. The reduction in average outstanding of 14% for linked quarter is attributable to our focus on credit and tightening of underwriting guidelines. This line of business continues to be a right spot for the bank as marketing conditions has created opportunities for both improved pricing and terms. I am confident our business model of hiring experienced bankers as well as our position as a broker bank.

We are primarily funded through the sweep accounts of our broker dealer. So, we are better positioned than our peers to these challenging times.

Our primary focus is building out our commercial banking franchise across Southwest and managing our asset quality. These are difficult times in the industry however, opportunities to retain and create relationships exist as competitors exit the businesses we competing it.

Thank you, and with this I will turn it back over Don.

Donald W. Hultgren

Thank you, John and before I continue let me just remind you that I mean if you do have questions in order to get in the queue you have press star 1, on your phone or if you would like to submit a question by e-mail, our e-mail address is questions@swst.com. Let we first refresh you on our market position as you know, we’ve spend a number of years focusing our business so that we can be fighting battles that we can win. And our current market position I think demonstrate, how we have positioned the firms to win those battles.

Today we are the largest brokerage firm that is headquartered in the Southwest part of the United States. We are the fifth largest bank headquartered in the city of Dallas. We are one of the largest clearing firms in the United State based on number of clients that we have. Turning to our map, this is a good tool for me to walk you through our strategic plan. As you can see, we have fixed income offices as well as public finance offices headquartered throughout the United State. And again we would reiterate with a shout out to those guys that they were a major source of our growth in this quarter

They like to focus on the blue states, which is the target market for both our Bank and our Private Client Group. We have identified that market because we think it’s a market that is unreserved bank financial services firms. Anything to the east to that appears to be pretty proud to us, anything north of that does not have the population density, that we find to be attractive. And so as you can see, you have identified in Southwest quadrant and the acquisitions of M.L. Stern helped us to significantly penetrate that market.

That being said there are not a ton of other brokerage firms that we maybe able to acquire in this marketplace. We continue to scour all of our resources to find additional acquisition here, but we also have the ability to grow in a notable fashion. The idea that there are not a lot of brokerage firms to acquire is precisely to the reason we are attracted to this market and why we want to build out Private Client Group because it will be a unique franchise in the country. That being said we also want to place our banks in the same area and as you know we fund many most actually of the banks deposits with the cash balances from the brokerage firm. So, we have ample resources to continue to grow that bank I would make one important distinction here regarding our bank John’s team has got about 1.5 billion in assets on the balance sheet 1.5 billion in loan.

Virtually all of those loans were underwritten by our bankers, being that all of those loans represent individual relationships in the communities where those loans were made and again when you look at the blue state as we continue to develop those kind of relationship at the bank level and at the brokerage level. I believe we are creating the franchise that we’ll have substantial value down the road. Let me now turn it to our corporate direction and you heard this for many, many quarters that we wanted to grow the theory business. We wanted to grow the broker dealer and we want to grow the bank.

Let me start first with growing the broker-dealer. We are good alternative to financial professionals especially in this difficult market environment. We do the financial advisors as our customer it is our job to provide those advisors with the platform that they need so that they can build their business in a way that’s best for their customers. We will continue to pursue those financial professionals and offer them a unique platform what they are allowed to do their business in a fashion that they believe is in the best interest of their customer.

Let me reiterate that this is not just however our retail strategy. We have been aggressively growing our institutional ranks of banker sales people and traders and so we continued to focus on both the retail and the institutional size of the broker-dealer. In terms of growing the bank we have added many talented bankers who are in the process now growing their loan portfolios with us. We have ample deposits and adequate capitals to facilitate this growth. In terms of growing the clearing business as you heard before we continued to have excess capacity.

Our clearing business is an opportunity for us we able to generate substantial operating leverage we own our own system, we run a fixed cost operation. So, the benefit of incremental revenue to earnings is significant. As you know, we have invested substantial sums in people in terms of new management and sales people and others in this business. And as they began to produce revenues, we should begin to see that operating leverage that is part of our clearing operation.

Finally, I want to talk about acquisition opportunities this is the time of great opportunities for SWS group. In recent years, we have succeeded in focusing the firm on those business areas where we have the ability to capture market share. We have brought in professionals with fresh ideas and energy to help us grow the bank, the broker dealer and our clearing business. Our balance sheet also remains strong. We are well-positioned at a time when many in our industry are struggling.

I believe this confluence of conditions means that 2009 is a year in which we should be able to expand through acquisition in our core businesses. Hopefully, the credit markets will loosen and provide greater access to capital. We would like to put some leverage on our balance sheet to improve the returns to shareholders.

I look forward in the quarters ahead to be able to talk with you about both our internal organic growth and any other potential external opportunities that we can successfully identify. In closing, these are exciting times at SWS Group. We are financially strong firm facing unusually good opportunities in this tough market. I want to thank our employees who go above and beyond the call of duty everyday, SWS Group has great employee and I am proud to be on this team. I want to thank our customers. You are the reason we are here and we strive to earn new business everyday. And finally I want to thank the shareholders for your confidence and support, and I look forward to sharing our progress with you in upcoming quarters. With that, let me open it up for questions it’s *1, on the phone or questions@swst.com.

Question-and-Answer Session

Operator

Thank you, the first question comes from Hugh Miller. Your line is open.

Hugh Miller – Sidoti & Co, LLC

Hi, good morning.

Unidentified Company Representative

Good morning Hugh, how are you?

Hugh Miller – Sidoti & Co, LLC

Good. I had a question, I think John you may’ve mentioned that they were, you guys are looking to injection capital into the Bank in the March quarter. I wanted to see that was a correct statement and, if so at what particular level will you take that up to and how will that be funded?

Kenneth R. Hanks

This is Ken. Well we plan on injecting what - at the time that we do it. Amount that will keep the Bank at a well capitalized levels for a substantial time even if they continue to have relatively flat earnings.

Hugh Miller – Sidoti & Co, LLC

Okay, I know that you guys are at about 10% now on the total capital ratio, is there a target on getting that up to a certain particular level?

John L. Holt Jr

Yeah, this is John and we would certainly like to have a little bit of vision there and so I’d anticipate that we would get it up by more in the 10.5% to 11% range.

Hugh Miller – Sidoti & Co, LLC

Okay great and then – and how would that typically be done in and funded?

Unidentified Company Representative

We seem to be a little, invasive it’s because lot of times our Board likes us to be clear it with them before doing them. So I have and move the capital around. That’s one we are kind of waiting to chat with them about this. Before we make any more public statement.

Kenneth Hanks

We do have Hugh the broker-dealer has excess capital of over a $125 million. And we like to operate at least a minimum of 100 excess capital there and we like to have cushion there. So it’s going to something less than that number obviously, but somewhere it’s going to be a 5, or 10, or15 type amount.

Hugh Miller - Sidoti & Co, LLC

Okay, certainly understandable and how should we be thinking about loan growth at the Bank, given I guess the current capital levels and the operating environment obviously, during the quarter we saw a strong growth in the commercial side. I guess it alluded to some deterioration in that market that you were experiencing. How should we be thinking about the growth at the Bank from a lending standpoint?

John L. Holt Jr

Hugh, this is John. I can take that question. We’re really looking at probably a slower growth rate, but we’re requiring more stringent and underwriting guidelines so what we are looking at lower loan to values, stronger cash flows, but there is a lot of competitors that are exiting the business today. So we still have some opportunity to grow the loan portfolio.

Hugh Miller – Sidoti & Co, LLC

Okay, and when we’re thinking about it some product standpoint, are there certain products you guys see better opportunities with from a lending standpoint and certain ones that you are going to look to positively see some compression in the portfolio?

John Holt

Well clearly the residential construction has been running off and I think we’ll continue to see that for the foreseeing, or upcoming quarters. So I would anticipate that C&I, SBA and the general commercial relationship that loans increased.

Hugh Miller – Sidoti & Co, LLC

Okay, and you guys had alluded to an anticipation that the charge offs will increase in the coming quarters possibly because of the commercial real estate market. What type of level I guess, are you guys comfortable in the coming quarters with seeing that charge-off rate get up to?

John L. Holt Jr

I don’t know that we really have and the fund progression of where we think it will go. Obviously if we do get piece of property back we had to have it appraised and take it back in and then and there has to be a market then further spell it out. So today we haven’t had any, huge charge-offs although in the commercial sector the charge-offs when you do have them and to be larger than they are in the residential arena.

Hugh Miller – Sidoti & Co, LLC

Okay, yeah. Can you give us a sense of the LTV for the commercial portfolio a rough figure there and also on the construction side?

John L. Holt Jr

I don’t know that this would be a shock, but my guess is that it’s going to be below an 80% loan to value within the commercial portfolio.

Hugh Miller - Sidoti & Co, LLC

Okay. And the provision levels as you guys have mentioned that you are expecting them to be somewhat in the ’09. So far what we’ve seen in 2009 for fiscal 2009. I would anticipate though that that’s going to be probably more at the December quarter’s levels go forward, is that correct?

John L. Holt Jr

I would anticipate that going up. They can be coming closer to the 1% range over the next three quarters.

Hugh Miller - Sidoti & Co, LLC

Okay.

Kenneth R. Hanks

Yeah, I think that’s really the key Hugh this is Ken is, that we expect that with the total provision the allowance is going to start to inch up toward the 1% level, we expect that our provision versus the charge-off is going to be similar to what has in the past which allows us to inch up. So that means while the charge-offs may go up or down, we’re still anticipating that they are going to be less since the income statement.

Hugh Miller - Sidoti & Co, LLC

Okay and one last question on the Bank. Do you guys anticipate higher FDIC premium costs for calendar ’09? And if so how much would that potentially be?

Unidentified Company Representative

With that question the answer there would be yes, higher FDIC cost is in the coming quarter all it’s going to be approximately double, but we don’t know what further increases should occur after that depending on the number of banks with the FDIC actually takes over?

Hugh Miller - Sidoti & Co, LLC

Okay, and so from a cost standpoint from the first quarter, do you have a sense of a total dollar amount, that that line increase?

John L. Holt Jr

Not right off but Hugh I can get back with you on that.

Hugh Miller - Sidoti & Co, LLC

Okay, great. I guess I’ll step back into the queue and let’s some other people ask.

John L. Holt Jr

Thank you.

Operator

Your next question comes from Edward Hemmelgarn your line is open.

Edward Hemmelgarn – Shaker Investments

Good morning. A couple of questions. One can you give us a little bit more of an outlook for the institution because there is clearly where you drove your all of your performance during the quarter. I mean, you actually didn’t have anything else that grew, but you had some awfully strong, commission increases. Do you expect that to continue? Or is that or do you expect it to more moderate in here?

John L. Holt Jr

Well, it is a tough comp. Today and it has continued to look very strong. Our fixed income group on the taxable side has historically been very focused on corporate debt. And there seems to have been quite an influx of interest in that side of the market, perhaps because of all the issues in the asset-back side of the market or perhaps because there really isn’t a lot of yield available in the government side of the market. So we are seeing continued, very strong growth in that segment right now. And you know, as I said it’s hard to know how long that goes, but we are diversified, or when I would assume that if there is a change to equities let say we would benefit from that in an other part of the firm.

Edward Hemmelgarn – Shaker Investments

Okay. You know once again I think you are talking about this just then your – your loan loss reserves relative to your non-performing asset that seems to be whether low compared to any other banking institution and, given that its – it’s the exposure is almost entirely to, real estate with the level of borrowing or, its seems like one might be a little bit more prudent with that in a higher reserve curious its your thoughts on that.

John L. Holt, Jr

Yeah this is John and like the comment better was – or with as I should say it is based on inherent losses and historical performance that rate, where we’d like to see that little bit hurdles we have to based it on inherent losses that we don’t have inherent losses that we know about its foreclosure then, order that as we are looking at – at inherent losses then historical, performance and so there our methodology is in place (to leaving that).

Edward Hemmelgarn – Shaker Investments

So, what about the impact of decline, continuing decreases in both residential and commercial real estate values and, one impact is that going to have on, real estate that you are currently holding against non-performing loans.

John L. Holt, Jr

well I will, we are able to increases done what everybody’s part of the methodology on the OTS’s Midwest regions so, as the rest of the region continues to – deteriorate and obviously we can – can allowed that the allowance to go up

Edward Hemmelgarn - Shaker Investments

Okay. Thanks.

John L. Holt, Jr

Thank you.

Operator

The next question comes from Joel Jeffrey. Your line is open.

Joel Jeffrey – Keefe Bruyette & Woods

Good morning.

Unidentified Company Representative

Good morning Joel. How are you?

Joel Jeffrey – Keefe Bruyette & Woods

I’m fine.

Kenneth R. Hanks

Good.

Joel Jeffrey – Keefe Bruyette & Woods

Quick questions, in the queue, it looks like that you’ve sold $56 million of auction rate securities in the quarter was there any gain or loss from that? Where it was a lot – not on the sales, all the gain we got from that was on the coupon?

Kenneth R. Hanks

We bounded part or settlement as like its posted.

Joel Jeffrey – Keefe Bruyette & Woods

Okay. And that on just looking at the private client business. And I am just curious about the sort of I guess I said that sort of the legacy business excluding M.L. Stern, what specifically, drove the sort of under performance in that area.

Kenneth R. Hanks

That markets; there is the small amount of gains for few years.

James H. Ross

This is Jim Ross.

Kenneth R. Hanks

I am sorry. The private client group the legacy business is very much traditional product mix and its very equity oriented. We’ve in the last three years. The product mix in the legacy grew it has been shifting to have particularly more into the fee base business and more into the insurance product, but both of those are very susceptible to volatile markets that the lower dropping values in equity et cetera. It is one of the reasons if you look at and while we’ve happy about our combination with M.L. Stern. M.L. Stern is very, very oriented to the municipal markets particularly in California They do a great job in that business of well established and so they’ve had been in the suit spots service fee, and then the – the legacy business is just opposite quite honestly, I am happy to report that M.L. municipal business in legacy or taxed fixed income has gone to 7% of revenues compared it was traditionally 1% of revenue so the legacy guys are starting to the make change in their business model.

Joel Jeffrey – Keefe Bruyette & Woods

Okay, great. And then from the clearing business I mean given that the significant fall off in ticket volume I mean does the reaction make sense to service day traders such as sort of seeming a municipal decline in revenue?

John L. Holt, Jr

Yeah, I think – this is John again it doesn’t make sense I mean the day traders, are, it can be a big business, I mean the fall off was because of the one of our bigger customers being acquired, but, the combination of both the day traders and general security side does add up to – to a decent business. And, it just that the ticket charge obviously is very low on day trading, but the volumes are very high and our systems, allows big volume. So, it’s a good bit fit for us.

Joel Jeffrey – Keefe Bruyette & Woods

And I – I guess in this environment is it easier to pick up new clearing customers and more difficult.

John L. Holt, Jr

It’s more difficult, the reason being that, when you got general securities from that struggling with the marketplace they were in right now. And your clearing salesman call up and says how about thinking about change in clearing firms, that - that’s kind of crazy call right now.

Joel Jeffrey – Keefe Bruyette & Woods

Okay, and then just lastly is there any kind of severance charge in the headcount reduction for bank that we can expect?

John L. Holt, Jr

It’s a small charge I can get back with you on that fairly just fairly and significant it's the going as the cost going forward is where the savings are.

Joel Jeffrey – Keefe Bruyette & Woods

Okay, great

John L. Holt, Jr

Thanks very much.

Joel Jeffrey - Keefe Bruyette & Woods

Thanks Joel.

Operator

The next question comes from Chuck Griege. Your line is open.

John L. Holt, Jr

Good morning.

Chuck Griege – Blue Lion Capital

Good morning guys. Just a couple of housekeeping issues, I was wondering if you can give us a little more color on the loan portfolio performance for a quarter ending December in terms of the 30 day to 89 day bucket, past 90 days and then year-over-year?

John L. Holt, Jr

Griege, this is John. I will go with that one. The REO is primarily residential. If we look at a $13 million, $15 million REO portfolio, $12 million in that is going to be in the residential bucket, it was the reminder being in the commercial real estate so, it’s fairly – fairly small there and then 90 days pass through. We have about $2.3 million in the residential side and about 4.6 and commercial real estate and then in the non-accrual area $8.9 million is residential, 13.5 million…

Chuck Griege – Blue Lion Capital

I’m sorry, could you, could you give those numbers again – I’m too passionate to write them down.

John L. Holt, Jr

Okay, and that actually a page here in the - page 50 in the Q that we filed this morning.

Chuck Griege – Blue Lion Capital

Okay. And how about the 30-day to 89 day bucket overall.

John L. Holt, Jr

I don’t have those numbers right here available, but we can certainly look and see what the numbers are in that area. But those are not in the reported documents.

Chuck Griege – Blue Lion Capital

Given the sequential increase in NPA is it, is that directionally, or decently way to think about likely what’s happening in the 30 day to 90-day bucket.

John L. Holt, Jr

I think that would be – that would be a better statement.

Chuck Griege – Blue Lion Capital

So, that means 390 bucket could also be up by 33% since your fiscal year?

John L. Holt, Jr

You starting to look at the…

Chuck Griege – Blue Lion Capital

And the REO is up by 50%?

John L. Holt, Jr

I will have to look back on the previous quarter if that – it had been flat 13 - $14 million level several quarters down.

Chuck Griege – Blue Lion Capital

I mean in light of that don’t you think your allowance should be a little higher?

John L. Holt, Jr

Again if by our auditors would sign off on the inherent risk. We have to go by the methodology and the inherent risk we have in the portfolio and based on the historical losses. and then the reason there is because they don’t want anybody managing earnings out of their loan loss provision.

Chuck Griege – Blue Lion Capital

Okay. And then second question, I would have for you is, could you a talk a little bit of more about what’s happening in your institutional business particularly with the gain that we saw in the quarter and maybe just tell us a little bit more about where those occurred and what you see that’s far in this quarter?

John L. Holt, Jr

Well I mean gain again it was a byproduct of the significant activity we had in the fixed income area. I mean we were not only, generating commissions, but they were gains from the quarter – from the inventories that we were holding it, at the same time. And so virtually, all the growth that you start in the institutional side, it was related to very robust fixed income area both on the corporate and the municipal side, whether it would be commissions or portfolio gain.

Chuck Griege – Blue Lion Capital

And but, generally speaking, corporate spreads really blew out in the fourth quarter and municipal bonds are also weak. And then I am surprise you would have gains on the portfolio at least in the last quarter.

John L. Holt, Jr

Well, I don’t know, I am just - I guess it’s a good surprising.

Chuck Griege – Blue Lion Capital

Okay, thank you very much.

John L. Holt, Jr

You bet.

Operator

The next question comes from Hugh Miller. Your line is open.

Unidentified Company Representative

Welcome back.

Hugh Miller – Sidoti & Co

Thank you, thank you very much. Just looking at the sequential decline in the independent reps on and I guess in net basis the retail brokerage segment. I was wondering maybe if you could provide us with a little inside, as to what was happening there?

Unidentified Company Representative

Hugh?

Hugh Miller – Sidoti & Co, LLC

Gentlemen.

Unidentified Company Representative

You are breaking out that it.

Hugh Miller – Sidoti & Co

I was looking at the sequential decline in the number of independent reps in the retail brokerage segments. I was wondering if you could provide us with a little inside as to what you were seeing during the quarter that led to that?

James H. Ross

Yeah, this is Jim Ross again. Historically, the independent cross contractors fourth quarter is when they are can further with an expense issue and that expense is renewing their independent contractor relationship renewing their licensing and we typically see a percentage of that grews that side that own quite anymore. They don’t want to do this anymore and that’s that the kind of the year to go back and work as discount in that fourth quarter this is historically in fact we’re pretty happy that we had a very minimal impact this year, as far as the number of people that decided to get out of that. So, to shorten my answer it is generally seasonal and that that decline and for same time we don't see the mass number today of people automatically running the independent contractor platform that we used to. But it's still a very robust platform there is a lot of people at a lot of firms considering going to an independent contractor. But it's not quite as attractive as it once was. That is one reason we are very fortunate in that we offer either an employee broker platform for the financial advisor and/or the independent contractor. You see both of these, the headcount for us is both stable and we are comfortable

Hugh Miller – Sidoti & Co

Okay. And I guess some following up on that can you talk a little about the opportunities you do see now given the consolidation we have seen from some of the larger peers with opportunities in both the PCG and the independents for hiring there? And just as a follow-up I know on the PCG side, that you guys added on a net basis three advisers but I was wondering what that figure may have been on a gross basis.

John L. Holt, Jr

I think on a gross basis, its gets very confusing because in this same period, you have got the M.L. Stern addition, which is a footnote in there, but if you look at this on the PCG Legacy side, I think the gross you have got net three and I think gross was six. We had a couple of year end retirements in there. We had one that actually, is in the headcount after the first of the year; going in to FS we had an employee decide to go to independent contractor. But also I would tell you historically we see very, very little growth in our headcount in fourth quarter for several reasons. One is a financial advisor generally doesn't want to move in the fourth quarter given all the holidays. Number two, his clients now are probably going to receive two 1099 at two different firms. The CRD systems closes in the middle of December and they post that would like, but we were very excited to see how much we did, in fact, loss on a policy basis in the fourth quarter. I am sitting next to the attorney, so if I get suddenly cut off here you will know why. We are very excited about the pipeline of recruiting as we are into the third quarter. He hasn’t hit me yet.

Hugh Miller – Sidoti & Co

Okay, great color there and I guess, in moving to the Clearing segment obviously, you guys have mentioned that you think the pipeline is so much strong but that in this current environment, it will difficult to get someone actually make a switch. Can you talk about what you guys see I guess, it’s a realistic timeframe to possibly see some larger correspondence coming on to the platform.

John L. Holt, Jr

I’m ready right now. You know we have made a big push in that area, Hugh, and we have got some very talented people and I think we have the boots on the ground that we need I think we are making the calls that we need to make. And so I am ready.

Hugh Miller – Sidoti & Co

Okay, great. Thank you very much for the color.

John L. Holt, Jr

Thank you.

Operator

The next question comes from Joel Jeffery. Your line is open.

John L. Holt, Jr

Hey, Joel.

Joel Jeffrey – Keefe, Bruyette & Woods

Hi, guys. Just two quick follow up questions. On the comp expenses, the ratio seemed elevated was that to the revenue mix?

John L. Holt, Jr

Ken, I’m thinking about it.

Kenneth R. Hanks

Well, I think elevated.

Joel Jeffrey – Keefe, Bruyette & Woods

It looked like it came in around 63% and it traditionally had been around 60%. I am just wondering it was more because you had variable comp due to the – to the increase…

Kenneth R. Hanks

Definitely variable comp. Variable comp as it relates to both the mission compensation and the bonus compensation in the very profitable business units

Joel Jeffrey – Keefe, Bruyette & Woods

So I mean it just a level we should be thinking about for the remainder of the year or is it likely to sort of swing back down maybe a little bit just based on potential revenue mix changes.

Kenneth R. Hanks

It will be based on the revenue mix?

Joel Jeffrey – Keefe, Bruyette & Woods

Okay and then just an – just to a followup question on the TARP funds and did you actually receive approval or did you pull application prior to any response from government?

Unidentified Company Representative

Well I will try to take that in front of John. We originally put our application in last, late last year because we want to save place inline. Basically because we are going to expire if you didn’t an application and you would not be able to go forward as of time we did not know if we really wanted to go forward are not quite right, but so we put the application in and we got to a point in application process were we said yes go on, it was going to call significant amount of work on behalf of regulators in the government and so we just started to take and really hard look at it and say we’ve really going to want this money if we are going to make them do all this work. because we are not going to be very happy with us otherwise, and we decided that the chances of its really wanted the money were so low that we just withdrew.

Joel Jeffrey – Keefe, Bruyette & Woods

Okay, so in I guess the application went in, but you never finished the whole process

James H. Ross

(Multiple Speakers) Right, it's a multiple step process. And when we got to that kind of ownership part of the part that’s where we were going to be the FDIC and the treasury really to do a lot of work we decided that we do would not go forward

Joel Jeffrey – Keefe, Bruyette & Woods

Okay great.

Operator

At this time, sir there are no further questions.

Donald W. Hultgren

We do have one that came in online asking about noticing that we don’t have a lot of analyst coverage and wondering whether we are trying to pursue additional analyst coverage in, what we are doing to increased our exposure to the investment community and them, and so, right now I’d say we’ve got a couple of analyst who are writing on us and one way to look at is that its prices many of that we’re right now from this time last year. So we are making some progress and we hope to attract additional research. We do spend a lot of time visiting with institutional shareholders. In fact at were 92% own by institutional investors and so, we do make an effort to go out and see the institutional shareholders and we would welcome any analyst would want us to come see them or want to come Dallas in and a very time a year to be Dallas. Any other questions. And with that, again thank you all very much for tuning in. Do we get one? No, okay anyway thank you very much for participating in our call we appreciate your support and we look forward to again talking with you next quarter.

Operator

Thank you for participating in today’s conference you may disconnect at this time.

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