Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Philip Pendergraft - Chief Executive Officer

Kevin McAleer - Chief Financial Officer

Analysts

Chris Donat - Sandler O’Neill

Ken Worthington - JP Morgan

Mike Vinciquerra - BMO Capital Markets

Patrick O’Shaughnessy - Raymond James

Mark Lane - William Blair & Company

David Scharf - JMP Securities

[Ravi Chopra - Sandler Capital]

Jeff Graph - Springhouse Capital

Penson Worldwide Inc. (OTC:PNSN) Q4 2008 Earnings Call February 6, 2009 10:00 AM ET

Operator

Good morning and welcome to the Penson Worldwide conference call. Before we begin, I’d like to read Penson’s Safe Harbor statement. Please note this presentation contains certain forward-looking statements about the management’s goals, plans, and expectations which are subject to various risks and uncertainties, outlined in the risk factors section of Penson’s Securities and Exchange Commission filings.

Actual results may differ materially from those currently anticipated and we disclaim any obligation to update information disclosed in this call as a result of development, which occur afterwards. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. (Operator Instructions).

I’d now like to turn the floor over to Mr. Philip Pendergraft, Chief Executive Officer. Mr. Pendergraft, you may begin.

Philip Pendergraft

Thank you. Good morning and thank you for joining us today. I am here today with Kevin McAleer, our Chief Financial Officer. We’ll discuss our quarterly results first and then take your questions. I’d like to start by saying that while we would have liked to have done better, we are not displeased with our pro forma results, especially in light of the very difficult market environment during the fourth quarter. On the other hand, we are obviously not pleased with our GAAP results, a loss of $0.43 per share.

This of course included a loss of $0.69 per share from the write-off and expenses associated with Evergreen Capital, which we will discuss more fully in a few minutes. Excluding that, we would have earned $0.26 per diluted share. This includes a negative impact of approximately $0.02 related to significant exchange rate changes between the third and fourth quarter, which primarily impacted the translation of our Canadian results into U.S. dollars.

It also includes a benefit of about $0.05 per diluted share due to a lower effective tax rate, primarily due to tax credits in our Canadian operations. These credits were unrelated to the Evergreen situation. Revenues declined by approximately $10 million on a sequential quarter basis. Of that, $2.9 million was due to the exchange rate differentials. Most of the effect was on our non-interest revenues, clearing and commission fees in particular.

Given the complexity of the quarter, we thought the easiest way to explain everything that happened was simply to go through the fourth-quarter income statement and balance sheet in detail. Let’s start with net interest revenues, which were down $8.2 million from the third quarter. This was more than we had expected. Our net spread on interest-earning balances fell by 31 basis points to 85 basis points and there were four factors involved in this.

The biggest variance was due to the three rate cuts of course, which moved the average fed funds rate from 200 basis points in the third quarter to 106 basis points in the fourth quarter. This cost us about $3 million in net interest revenue, in line with our projected interest-rate sensitivity.

Second, about $2 million of the variance was due to a 13% decline in interest-earning balances as customer, stock loan and margin balances were down. This is our first sequential quarter where we’ve seen a decline since the third quarter of 2006 and we believe that this was primarily due to market declines and volatility in the last four months of 2008. While we had expected a decline, this was larger than we had anticipated.

Third, net interest income from our conduit stock lending business declined $1.4 million in the quarter. Conduit balances were down sharply as of the end of the third quarter, as a result of the emergency short sale rules implemented in September.

However, we had anticipated that balances would begin to recover in the fourth quarter. Instead, they declined an additional 51% to a December 31 balance of $572 million. As expected, the spread did increase to 89 basis points, up from 57 in the third quarter as access to borrowable shares became more valuable, but this increase in spread was not enough to offset the impact of the balance decline.

Fourth, we believe that credit market dislocations, which continued from the third to the fourth quarter cost us another $1.7 million in net interest revenue. For much of October and November, we earned less than expected on our segregated funds and paid more than expected on our financing lines. This was primarily because of unusual differences between targeted and actual fed funds and premiums charged on financing lines.

Now, as we look forward to the first quarter, we expect a modest recovery in net interest revenues. First of all, the credit market dislocations had largely subsided by the end of November. Second, we are taking advantage of the large rate disparity between short-term bank rates and fed funds to move some of our segregated investments into insured bank deposits.

We believe that this will offset the impact of the lower average fed funds rate between the fourth and first quarters and we are hopeful of a small increase in interest-earning balances in the first quarter based upon the November and December trends.

On the other hand, we do expect that conduit net interest revenue will be down in the first quarter, primarily because of lower spreads when compared to the fourth quarter. Our balances have been fairly stable since December. All together, we anticipate that these factors will result in a similar net spread on our customer interest-earning balances between the two quarters and a modest increase in overall net interest revenues.

Now, let’s look at non-interest revenues. They were down just over $2 million from the third quarter, but that includes a $2.6 million decline due to the negative exchange rate differential, of which $2 million affected clearing and commission fees and $600,000 affected other revenues. While trading activity was generally strong in October and November, there was a meaningful drop-off in December especially in the last two weeks, where we saw declines of 40% in equity transactions. This was an unusually large seasonal effect. Last year for example, equity transactions were down only 15% in the last two weeks of December.

For the quarter overall, equity volumes were up slightly, but futures volumes fell 7.5% and options volumes were down 14%. On a reported basis, clearing and commission fees were down 9% on a sequential quarter basis, but up 5% year-over-year. Excluding the effect of currency translation, these revenues were down 4% sequentially, but up 13% year-over-year. The year-over-year increases reflect higher volumes and the new business we’ve added this year.

Other revenue, on a reported basis increased by 16% on a sequential basis and was down slightly year-over-year. Excluding the effects of currency translation, other revenue increased 21% sequentially and 5% year-over-year. The growth here was primarily due to our trade aggregation program. We believe that this program will be positively impacted by some of the recent exchange pricing changes and by opportunities to expand the product into the European marketplace. So, we are optimistic about growth in this area in the first quarter.

Our technology business, Nexa Technologies, also continue to perform well. On a sequential quarter basis, revenue continued in $6.1 million range. That is primarily due to our maintaining high levels of recurring business as correspondent expanded their client base. I’m also pleased to report that, for both the quarter and the year Nexa was in the black. This is the first full year that the operation has been profitable. It represents a significant turnaround from the loss in 2007 and we believe it will continue to be profitable in 2009.

Excluding Evergreen on a consolidated basis, all operations were profitable in the quarter, with the exception PFSL our U.K. subsidiary. While we are disappointed with that, the loss at PFSL was lower than in the third quarter. While we are signing new business in the UK as anticipated, due to the market conditions in the fourth quarter, it has taken us a little longer than expected to convert that business. With new business coming on board this quarter, U.K. is expected to be in the black.

In fact, we believe that 2009 will be a very good year for PFSL. Our new client prospects are very strong, partly due to changes in the European market driven by the EU’s MiFID directives. We also recently added a senior securities lending executive to the UK team and are planning an expanded effort in this area in the European and Asian markets.

Penson GHCO had another good quarter with segregated funds averaging $404 million, a slight increase from the third quarter. Most of our competitors in the futures space are reporting declines in Seg funds, as commodity prices and volumes continued to be depressed. Our new client additions headlined by the Alaron conversion at the end of the third quarter, have helped to us overcome these negative industry trends. Our U.S. clearing business, PFSI, had a good quarter although it was the business most affected by the decline in interest rates and balances.

As we have indicated, we are continuing to focus on expanding our execution services offerings primarily through PFSI. In addition to our trade aggregation product, which we mentioned earlier, we’ve also launched a suite of algorithmic products under the name, PARs, or Penson Algorithmic Routing. PFSI also became a member of the New York Stock Exchange during the quarter, which has opened up new clearing and execution services opportunities.

Now we are working on a significant expansion of our execution services business. Taking advantage of our increased volumes, the customers we’ve attracted through trade aggregation and our New York Stock Exchange membership. We expect the launch a number of new products to provide liquidity and generate more revenues from existing correspondents. We plan to launch this initiative in the second quarter as Penson Execution Services, a new operating business to be headed by Dan Weingarten, one of our co-directors of global sales and marketing.

We also plan to launch our retail foreign exchange offering in the second quarter under the brand of PFX. We will be providing a turn key product offering for our correspondents to offer to their clients, allowing a full range of FX margin trading. We believe this to be an important step forward in our vision of enabling multiple asset class trading in a seamless manner. This initiative is headed by David Faller, who joined us during the fourth quarter as director of our global FX business.

As for new business, we had another good quarter in that area especially considering the market environment. We added a net two new revenue generating correspondents, one in the securities operations and one in futures to bring our total of 302. Now we actually added 13 new firms in the quarter and lost or terminated 11. Our turnover rate was higher than normal, reflecting the difficult operating environment in the quarter.

However, we are continuing to upgrade the quality of our correspondent clients as non-interest revenues per correspondent reached $739,000 last year, a new record. Not reflected in our fourth-quarter correspondent camp is our pipeline, which totals 23 new correspondents. We anticipate that these correspondents are likely to begin contributing to revenues in the first half of this year. Four of them were signed in the fourth quarter and 19 are from prior periods.

Again, new client signings were lower than in previous quarters due to the market environment that we faced in the quarter, but we have had a strong January in this area. We should also note that not included in these numbers are nine securities correspondents which signed futures agreements with Penson GHCO during the fourth quarter as our cross-selling efforts in this area continue to bear fruit.

During our last earnings call, we indicated that we expected earnings and revenues to be relatively flat on a quarter-over-quarter basis. Given that actual results were down from these expectations, I thought it would be helpful to spend a minute going through the areas of difference. Pro forma EPS adjusted for both the exchange rate impact and the tax credits was $0.23, $0.06 lower than last quarter’s GAAP $0.29.

On our third-quarter call, we indicated that we anticipated that net interest revenue would be down around $3 million in the fourth quarter, about half of that from the impact of lower interest rates and about half from the combination of lower balances and the credit market pricing dislocations. Actually, net interest revenues were down more than $8 million, with $3 million coming from lower interest rates, including the impact of rate cuts announced after our earnings call and about $5 million from the combination of lower balances and pricing dislocations.

We had anticipated that growth in non-interest revenues would make up for the expected declines in interest income. The greater than expected declines in net interest revenue combined with the $2.6 million exchange rate impact and the slower than normal December caused us to miss this expectation.

Now I’d like Kevin to spend a few minutes talking about operating costs and some other matters.

Kevin McAleer

Thanks, Phil. Excluding the $2.4 million Samco litigation reserve in the third quarter and the Evergreen-related write-off and expenses in the fourth quarter. Expenses of $60.5 million were down 7% on a sequential basis. The key variances were, in compensation declined 3% or a little less than $1 million. This is primarily due to lower compensation-based revenues and overall company performance.

Our floor brokerage fees fell 41% or about $3.5 million. The fourth quarter is typically one of the lowest quarters for this expense category as clearing agencies reduced their fees, the lowest level of the year and rebate excess annual earnings. This decline also reflects lower clearing and commission fees. The other expenses were up 16% or $1.4 million on a pro forma basis and this is primarily due to higher professional fees relating to system expansions that we’ve talked about in prior quarters and legal fees.

As a result, pro forma operating margins of 12.3% compares to 18.2% in the third quarter and 21.2% in the fourth quarter of ‘07. You can attribute the variance almost entirely to the change in net interest revenue during the quarter as previously discussed. As we noted in the news release, we had a $1.3 million benefit primarily due to prior year international trade tax credits. This lowered the effective pro forma rates to 22.3% from 38% and benefited pro forma earnings per diluted share by about $0.05.

We anticipate receiving this credit in 2009; however we do not anticipate that it will be significant. To avoid significant dilution, we decided to accrue Schonfeld acquisition-related incentive payments in cash instead of shares for the trailing seven months through December. Our agreement enables us to use cash incentive shares, if the price of our stock is less than an average of $15.30 during the period.

Now turning to the balance sheet, assets were down by approximately $1.9 billion between the end of the third quarter and the end of the fourth quarter. A number of items contributed to this decline with the single largest item being a reduction of receivables from brokers and clearing agencies. This reflects a decline in unsettled trades having no impact on interest-earning balances. This decline was primarily due to lower trade volumes at the very end of the year.

Overall, interest-earning balances were down an average of $650 million for the quarter, hitting the low point of $4.1 billion during November and rebounding to $4.3 billion in December. Finally, we are in the process of reviewing our $75 million revolving line of credit. Based on our discussions with current and prospective bank syndicate members, we anticipate completing this transaction in the near-term.

Now back to you, Phil.

Philip Pendergraft

Thanks, Kevin. On October 31, we announced an unsecured receivable from Evergreen Capital in the amount of approximately $25 million. After extensive investigation over the past three months, we’ve determined that it is necessary to write-off this receivable as well as a little more than $1 million in related expenses. These expenses are principally for the forensic investigation, which is nearing completion and for other expenses related to potential litigation.

It is important to understand that unlike the majority of our correspondents who focus on the retail space, Evergreen was an institutional broker and its clients primarily settled with us on a delivery versus payment or DVP basis. This means that we didn’t hold their customers assets as we do with more than approximately 95% of our other correspondents.

Now our inquiry conducted by the forensic investigator has thus far found signs of potential fraud by certain Evergreen personnel and some Evergreen customers. The investigator has also determined that there was no participation in the fraud by Penson personnel, nor was our technology at fault. We are working closely with the Evergreen bankruptcy trustee [Ernstein Young], to continue to gather information and seek potential recoveries. We are told that in the very near future there will be meaningful legal action on behalf of the estate, of which we are the largest creditor.

Now, I want to turn to a summary of the steps that we’ve taken since this situation was reported in October. Our first step of course was to determine exactly what happened and how it happened. We conducted a complete review led by the outside forensic investigation firm. We are cooperating with the appropriate authorities, working with them in regards to our investigation.

We use this information to review all of our operations around the world, looking for similar exposures, we did not find any. We’ve also designed several new risk management and fraud detection processes using what we learned from this situation to create risk-based warning flags and we are also expediting the deployment of technology, which will provide us with enhanced visibility into exposures on a global basis.

As I promised on our last conference call, we’ve also retained outside risk experts to independently review our risk management systems and procedures. This firm is Promontory Financial Group and they began their work in mid-December. This review is being led by two of our outside directors.

We’ve also had a number of personnel changes including the resignation of our Canadian CEO. We’ve begun the search for a replacement and in the interim; Penson Canada is being led by its Chairman and Founder, Raymond Desormeaux, Chairman of the Montreal Exchange and its President, John Skain who’s been with us since 2005.

During the fourth quarter, Canada’s continuing operations were strong especially considering the market environment. We did not lose any business as a result of Evergreen. Although we did lose Trade Freedom as expected as a result of their being purchased last year by one of the Canadian banks and because of the pending litigation, we can’t go into further detail on this at this time.

We hope you appreciate that we have thoroughly investigated the situation, that we are taking all available action for recovery and that we have used what we learned from this situation to meaningfully improve our fraud and risk detection management systems.

Now turning to 2009, we are optimistic that we are going to be able to grow revenues on a year-over-year basis, but we probably won’t hit our minimum 15% growth target. As we look at ‘09 versus ‘08, we think we will grow revenues somewhere between 5% and 10% and that net earnings will be flat with 2008 on a pro forma basis.

We anticipate that non-interest revenues will be up and that net interest revenues will be down modestly on a year-over-year basis as lower interest rates should be offset by balanced growth and the benefits of higher returns from bank deposits. Overall operating margins will decline primarily because of interest rates.

Now with regard to net interest revenue, as I mentioned earlier we are moving some segregated assets out of fed funds in the higher-yielding insured bank deposits. We plan to move between $500 million and $1 billion over the next quarter. If we’re successful in doing this, we believe that we can increase our spread by as much as 10 basis points in the second half of 2009.

Regarding non-interest revenues, as we discussed we’re continuing to add new correspondents and launch new products and we believe that both factors will offset the expected lack of volume growth in the markets on an overall basis this year. Now please remember, that our growth and performance will not necessarily be on a consistent quarter-to-quarter basis. There are seasonal factors which affect our business and we are impacted by market volumes as well.

We believe that the first quarter is likely to be the lowest quarter of the year from an earnings perspective and lower than pro forma fourth quarter results adjusted for the tax credits of course as seasonal expensive factors and lower market volumes in certain markets will likely negatively impact performance. Additionally, due to changes in monthly pricing policies, we do not anticipate any meaningful impact from depository rebates in the first quarter of 2009 unlike last year.

After the first quarter, we do anticipate earnings growth on a quarterly basis for the rest of the year. Now I would like to make a comment about the recent news regarding the combination of Thinkorswim and TD AMERITRADE.Overall, we believe that this transaction has the potential to be a positive for us. We think there is a real opportunity to grow our business with Thinkorswim through the end of our current contract, which takes us through the end of 2010.

As TD AMERITRADE Executives stated on their call, we also look forward to the opportunity to leverage our current futures and foreign exchange relationship with Thinkorswim into a much larger relationship with AMERITRADE.

That ends my prepared remarks. We appreciate your support and confident and interest and look forward to taking your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Donat - Sandler O’Neill.

Chris Donat - Sandler O’Neill

My first question here is related to the net interest income, Phil. You made a comment about balances declining in the early part of the fourth quarter and then coming back a little bit and also commented a bit on margin loans or margin balances. Has that been part of the rebound, because what we’re seeing from some of the online brokers is still more pressure on those margin balances.

Philip Pendergraft

Margin balances are essentially have not rebounded. When we look at our numbers in December and January, we are pretty flat with the November bottom. We’ve seen an increase, so the rebound is primarily in other areas.

Chris Donat - Sandler O’Neill

Okay.

Philip Pendergraft

So I guess to say at a different way. We haven’t gone down anymore, but we are sort of flat lined with our November bottom.

Chris Donat - Sandler O’Neill

Flat lined on an aggregate sense or in the margin balances sense?

Philip Pendergraft

Just margin balances. Overall, interest earning balances rebounded in December.

Chris Donat - Sandler O’Neill

Okay and then in terms of the new correspondents you are bringing on. At least last quarter the pipeline had 29 in it and you brought on, what 13 in the quarter. Is that sort of a useful way to think of it when the pipeline has X, maybe half of it empties in the current quarter or is there another way to think about it?

Kevin Mcaleer

No, I think that’s probably reasonable depending on market conditions. I think had market conditions not been so chaotic in the fourth quarter, we might have actually done a little bit better in terms of conversions.

Chris Donat - Sandler O’Neill

Okay, and then any color on those the 11 that you lost or that were terminated. You mentioned that you upgraded the quality. Anything quantitative you can point to there?

Kevin Mcaleer

So, on a year-over-year basis, average non-interest revenue per correspondent grew about 10%. So, the 302 in the back at the end of the year are contributing about 10% more on average, but unlike previous quarters where, I think last quarter our losses were not meaningful. We did lose a top 10 customer in the quarter, which was TradeFreedom in Canada and that was something we talked about prior. They were purchased by one of the Canadian Banks last year and finally converted out in early October.

Chris Donat - Sandler O’Neill

Okay and then in terms of your new initiatives here, I’m jumping around, but the new product you are launching. Have we seen any of those appear in your expense lines to-date and is that something that we can expect to higher expenses going forward as you launch these initiatives?

Kevin Mcaleer

You have seen some expenses related to these in the third and fourth quarter. Frankly, we think that for 2009 both of the initiatives I talked about are going to be breakeven initiatives, so we will build revenues to cover the additional expense base in the first in 2009 and we anticipate they will continue to earnings in 2010.

Chris Donat - Sandler O’Neill

Okay, are they part of the reasons behind your expectation that earnings will be lower in the first quarter and then ramp-up or are they not big enough to impact that?

Philip Pendergraft

They certainly have an impact.

Operator

Your next question comes from the line of Ken Worthington - JP Morgan.

Ken Worthington – JP Morgan

Hi, good morning. On the cross-selling, you had nine securities correspondent at futures capabilities. Can you tell us how the cross-selling initiative is going? I assume it’s small right now, but just too kind of keep track on how things progress, can you give us a metric to help us that on how big it is now, so we can track it in the future?

Philip Pendergraft

I don’t have the number at my fingertips, but we will get you the number -- we actually have 20 U.S. securities brokers are they currently have contracts with Penson GHCO and I believe that’s up from 11 at the end of the third quarter.

Ken Worthington – JP Morgan

Okay and so those 20. How much business do they do? I assume like are they small, I assume they are very small, but are they at all contributing on the future side, any metric there?

Philip Pendergraft

Ken, I don’t have a metric for you, but I can tell you that for example Thinkorswim is one of those and Futures and Foreign Exchange is a growing business for them and there is a number of our other, Lightspeed Trading is one of those firms. Lightspeed is actually now our largest correspondent and so we are seeing some of our most meaningful securities firms launch into futures and foreign exchange.

Ken Worthington - JP Morgan

In terms of the fraud detection, new risk technology and new risk procedures, what’s the incremental cost of these initiatives? Is it enough to kind of move a needle or they’re going to be pretty small in terms of expenses as well?

Philip Pendergraft

The technology, we were actually already deploying. So, I don’t think there’s going to be any additional cost related to that. Clearly there will be some costs in the first and second quarter related to the third-party review that has been a very extensive review and is not inexpensive. There will likely be a little bit of an increase from a personnel perspective, as we deploy new risk personnel or additional risk personnel, but I don’t think that beyond that there will be really anything meaningful from a cost perspective.

Ken Worthington - JP Morgan

Okay, great and then just last question. You mention on the call that the Canadian CEO resigned. Can you talk about the personnel change there? Kind of one side, there wasn’t really any fraud, but there was a huge loss. So I guess he was kind of captain of the ship up there. Just talk about the personnel movement?

Philip Pendergraft

I think that one of the principles of our business is that there has to be accountability and very early on in the Evergreen situation, our Canadian CEO came to me and said I’m ultimately responsible and I’m offering you my resignation because of this and we sort of put that on hold for awhile, while we were working through the problem and he was instrumental in working through it and helping us understand clearly what happened, but at the end of the day, we decided that because of the need for accountability that we would accept his resignation.

I think that he acted extremely honorably and professionally during the whole situation, and I really regret that he has left the firm, but ultimately I think it was the right business decision.

The firm is very adequately managed today or operated today, by the two gentlemen I mentioned. Ray Desormeaux has, I think has something about 40 years experience in the securities and futures business in Canada and he’s very well-known and respected and he is our Chairman and John Skain has close to 20 years experience. So while we are going to looking for a new CEO. I don’t have concerns about the leadership of that organization.

Operator

Your next question comes from Mike Vinciquerra - BMO Capital Markets.

Mike Vinciquerra - BMO Capital Markets

Back on the interest rates just for a minute, I want to make sure I understand what we are looking at going forward. So what is the rough mix of what your balances, your client balances are invested today before you start making the transition to the bank side?

Philip Pendergraft

They are all invested in fed funds investments.

Mike Vinciquerra - BMO Capital Markets

So essentially, all of those investments are earning 25 bips today, besides within your margin balances?

Kevin Mcaleer

Well, actually the majority of them, probably 90% of them is earning less than fed funds, or were earning less than fed funds because we were earning the effective rate not the targeted rate. That was part of the problem in the fourth quarter that targeted and effective had a very widespread.

Now, the future Seg funds are different. There are different regulations governing those investments and so we are on the $400 million or so in future Seg funds. We are earning or were earning something over 1% in the fourth quarter.

Mike Vinciquerra - BMO Capital Markets

Okay, all right. So it sounds to me like certainly the decline in margin balances did play a role, but almost sounds like the dislocation in the market was the bigger factor?

Kevin McAleer

Well, I think that’s a true statement, because all told the 13% decline in interest-earning balances, which included margin and stock lending balances, that impacted us by about $2 million. The pricing dislocations were about $1.7 million.

Mike Vinciquerra - BMO Capital Markets

And these insured bank deposits you are moving to, you called them insured bank deposits. Now for $500 million to $1 billion, you guys are actually going to have insured coverage on those?

Philip Pendergraft

Yes, we actually are because we get flow through coverage to our underlying account holder.

Mike Vinciquerra - BMO Capital Markets

Okay, so they have essentially individual accounts with the bank that you’re going to deposit with?

Philip Pendergraft

They have individual accounts with us and since we are fiduciary for their balances, we get flow through FDIC coverage.

Mike Vinciquerra - BMO Capital Markets

I want to ask, when I look at the yields on your balance sheet, you were still paying your clients about 76 basis points in the fourth quarter on average. I assume that’s going to drop substantially here in the first quarter?

Philip Pendergraft

Yes, the point to make there is that, that is the total expense including what we pay our customers and our correspondents. It’s not just what we pay on credit balances. It includes our stock lending balances, it includes our short-term borrowings. That’s our total interest expense, not just what we pay our customers.

Mike Vinciquerra - BMO Capital Markets

So on the conduit loan you are in the 2% plus range and so that’s certainly bringing that number up.

Philip Pendergraft

No, actually to be clear, it includes everything except the conduit loans.

Mike Vinciquerra - BMO Capital Markets

Okay.

Kevin McAleer

Conduits are separate, Mike on the schedule. They’re about 2.37 in expense.

Mike Vinciquerra - BMO Capital Markets

Then just shifting over to the clearing side, can you discuss maybe the timing of the expected client conversions kind of goes on the earlier quick question. Timing of client conversions here in the first half of the year were still 23. My guess is that the conversions may have been slowed a little bit to some degree by the turmoil in the markets in the fourth quarter; do you expect that to pick up here in the first?

Philip Pendergraft

We do.

Mike Vinciquerra - BMO Capital Markets

Did the conversions in the fourth quarter include a couple that you pointed out last quarter? I think you mentioned Scott Trade and Vander Meulen as being two potentially significant clients that had not started producing revenue yet?

Philip Pendergraft

They have now begun producing revenue.

Operator

Your next question comes from Patrick O’Shaughnessy - Raymond James.

Patrick O’Shaughnessy - Raymond James

I wanted to dig into the currency translation issue a little bit. Can you tell me what percentage of your clearing and commission revenues comes from Canada currently?

Kevin McAleer

I’ll get that for you, I don’t have the breakdown right in front of me, but I will get that for you. We saw an approximately 15%, 16% decline in the exchange rate and our Canadian dollar revenues for the quarter in U.S. dollars on the clearing and commission side were just under $9 million.

Patrick O’Shaughnessy - Raymond James

The next question I had was, as far as the market dislocations that went on during the quarter and some of the struggles are that some of your bigger competitors have been facing. How do you see the environment going forward as far as winning new clients, increasing your pipeline? It sounds like January was a pretty good month for that. So it sounds like, maybe some of the macro events are starting to work in your favor.

Philip Pendergraft

It was really interesting. I’ve heard from our sales and marketing groups really around the world that it was almost like somebody turned the light switch on when January 5, whatever the first Monday in January was rolled around. That all of the conversations, which had seemed to have been on hold in the fourth quarter all started to again. So I do think that we will see good new client signings in the quarter and I would expect that over the next quarter or two that our losses will begin to decline as some of this turmoil gets behind us. So, we’ll begin to see larger net gains in correspondents.

Patrick O’Shaughnessy - Raymond James

Okay, makes sense and then the last question I had was regarding the conduit balances. It sounds like you think they’re going to be pretty low for 2009 and that yields will be elevated, but probably comedown a little bit from what they were this quarter? I’m just trying to get a little bit better understanding why? What are the drivers behind that make you think it’s going to be a pretty depressed business for the next few quarters?

Philip Pendergraft

Actually, we don’t have clarity beyond this quarter. So, I’m really not making up projection about that for beyond this quarter at this time. I think it’s pretty clear it’s going to be down this quarter based upon where we are five weeks into the quarter. We’ve started to see a little bit of a rebound from our December balances. So, from our year-end balances, we started to see just a little rebound. So I’m hopeful that will continues, but I think when we look at average balances between the fourth quarter and the first quarter, I think it’s clear that we will be lower.

Operator

Your next question comes from Mark Lane - William Blair & Company.

Mark Lane - William Blair & Company

Good morning, first question is regarding the revolver. You said you were starting to look at it. What exactly does that mean?

Philip Pendergraft

Well, actually we’re actively in the process of renewing it and so we anticipate having that completed in the near-term.

Mark Lane - William Blair & Company

Okay and would the goal be to keep it at that level or extend the term or increase the size or all of the above?

Philip Pendergraft

Well, I would say that unlikely it will roll as a three-year term. Conditions are very different than they were when we first put this in place three years ago. Generally speaking, I think what we are hearing in the marketplace is that essentially a 364 kind of extension or renewal is really where the market is today. I think it is possible that we will extend the size to the extent that we find appetite in the banking community to do that, we would like to do that, but we are pretty confident that at a minimum, we will renew it at the current level.

Mark Lane - William Blair & Company

Okay and regarding the move from fed funds to bank deposits. Is there any plan or potential to do anything differently in the futures business or are we talking solely in the core clearing business?

Philip Pendergraft

No, we are looking at the investments in our future Seg funds as well and hope to actually be able to leverage, really piggyback off of some of what we’re doing in the brokerage business. What we don’t want to do and what we’re not going to do is create duration risk. So, everything we’re doing is really either demand or very short-term both in the futures and security side, but there is a very large disparity in today’s market between the yields on the bank deposits and fed funds.

Mark Lane - William Blair & Company

So, you couldn’t change the futures strategy without having the clearing business?

Philip Pendergraft

I’m sorry, I don’t understand the question.

Mark Lane - William Blair & Company

Meaning, you are trying to piggyback what you’re doing in the clearing organization.

Philip Pendergraft

I mean in terms of sort of buying power.

Mark Lane - William Blair & Co

Got it, so you could still accomplish that in the futures business independently? So are you talking about like one-month CDs and things like that?

Kevin McAleer

In some cases, they will be very short-term deposits but with a term. In a lot of cases, it’s just demand deposits with no term.

Mark Lane - William Blair & Co

Okay and so what’s the challenge? You said that if you are successful in doing it, why wouldn’t you be successful?

Kevin McAleer

It’s finding enough banks that we feel are creditworthy that will pay us what we believe is a fair rate.

Mark Lane, William Blair & Co

Okay and then regarding expenses, so your expectation for revenue growth in 2009. What’s your expectation about absolute compensation levels then? Can you hold comp level for 2009 versus 2008? Given what you have laid out. What would your expectations be?

Kevin McAleer

I do think compensation will be fairly flat year-over-year.

Mark Lane, William Blair & Co

Okay and then the last one are, and this is maybe not a question you can answer right now, but just as you think about this. In terms of the cross-selling and selling futures into the securities brokers, can’t you track the Seg fund balances in the futures accounts?

Kevin McAleer

Yes, we actually can, although it’s a little bit misleading because unlike traditional sort of standalone futures accounts, we sweep all excess funds back into the brokerage account. So, whereas a standalone futures customer, they could have excess funds in their account. In the cross sold accounts, it will just be the required Seg amount and we will sweep all excess back to the brokerage company.

Operator

Your next question comes from the line of David Scharf of JMP Securities

David Scharf - JMP Securities

A couple of things one, I apologize I just got a little confused on the math. I was just trying to work through the pipeline numbers. You had 29 at the end of September, looks like two of those were converted or became revenue-producing to bring you down to 27 and.

Philip Pendergraft

No, actually, David, I’m sorry to interrupt, we had 13 new firms begin in the fourth quarter.

David Scharf - JMP Securities.

Okay, so the 13 and 11 were lost out of the pipeline?

Philip Pendergraft

11 were lost out of the existing customer base.

David Scharf - JMP Securities.

So I’m just trying to focus strictly on the pipeline. So, we started with 29, 13 converted, became revenue-producing, which takes you down to 16 and then you are at 23. So you signed about seven.

Philip Pendergraft

You know, that math makes sense. The number in my notes says four so I have a discrepancy there.

David Scharf - JMP Securities.

So, I am just wondering if a few fell out of the pipeline.

Philip Pendergraft

That’s a good question. We will clear that up. I’m not sure what the right answer is.

David Scharf - JMP Securities.

A couple of other things, one we can obviously do the math and work on our model later on, but just wondering roughly the 5% to 10% goal for consolidated revenue growth and with interest revenue on a net basis slightly down. What’s the general outlook on the clearing side? I don’t know if other and technology are going to be down a little or pretty stable. Are we looking at generally kind of high single-digit growth, your expectations on clearing and commission?

Philip Pendergraft

I think that’s fair. I do think we will also see maybe low teen growth on the technology side and I think other revenue particularly because of our continued growth in our Execution Services business is likely to be up low teens as well.

David Scharf - JMP Securities.

Okay, got you.

Kevin Mcaleer

David, to your question on correspondents we had three that came in, converted in the converted in the quarter that were never in the pipeline, so they were new. We converted them quickly and they go into the count.

Philip Pendergraft

So that’s where the differential is.

David Scharf - JMP Securities

Okay, perfect, that’s helpful. Wondering about the correspondent mix heading into this year, there has obviously been a lot of activity with all the new conversions, but in particular when you look at that portion of your client base that’s historically been sort of professional trading, Algo trader, small hedge funds, there’s clearly been some more stress in that segment of the market. Can you give a little color on perhaps what percent of balances and volumes lately are coming from that segment versus perhaps a year ago?

Kevin Mcaleer

David, I don’t have that in front of me, but we’ll be happy to follow up with you later.

David Scharf - JMP Securities

Okay, fair enough, and…

Philip Pendergraft

I will comment though that the place where we probably see the most stress in our customer base is in the retail and online brokerage space. Those appear to be the firms that are struggling the most. The DMA, the active trading firms, the Algo guys, actually appear to be doing pretty well and the Prop trading firms.

David Scharf - JMP Securities

Okay, surprising and I know going back about eight or nine months, I was looking at some of your comments from, I think April or May last year. I think you made reference to a quant firm that you expected to be a top 10 client. I’m not sure what the timeframe was, if you recall that, but did that company ramp up as expected?

Philip Pendergraft

You know. It’s interesting, that is the one piece of business that we have that was negatively impacted by the Evergreen situation. That business ramped up nicely in the third quarter and after Evergreen, we have about half of that business and after Evergreen, the firm decided they would reduce their business with us to kind of see what happened and they did that and then in the second half of January they began to ramp their business back up. It weren’t in Canada, but here in the States, that’s the one piece of business that was impacted by concerns about Evergreen.

David Scharf - JMP Securities

Interesting, but that’s starting to come back?

Kevin McAleer

Yes, it’s beginning to ramp back up.

David Scharf - JMP Securities

Good, and also in the context of your comments on the Schonfeld remuneration. Any implications or sort of guidance on average share count we ought to be using in ‘09? I don’t know if that changes our assumptions at all from previous guidance. It sounds like you are going to be issuing fewer shares.

Philip Pendergraft

I think that really the only shares we would anticipate issuing this year would relate to really employee, I mean the vesting of options and RSU’s, that kind of thing. Unless our stock price in midyear is over $15.30 in which case we will be required to issue shares to Schonfeld. I think that would be a good problem to have.

Operator

Your next question comes from [Ravi Chopra - Sandler Capital].

Ravi Chopra - Sandler Capital

Just a couple of questions to start off on the balance sheet; can you guys remind us what your current cost is on the $75 million of notes that are coming due and maybe just a ballpark of how much you think it might cost you going forward when you renew it?

Kevin Mcaleer

Yes, to the current cost, it was LIBOR plus 150 and what we are hearing in the market is that it’s going to cost LIBOR plus 350 on the renewal.

Ravi Chopra - Sandler Capital

Sorry, so it was 150 currently and you are thinking roughly 350 going forward?

Kevin Mcaleer

Yes, that’s correct.

Ravi Chopra - Sandler Capital

Got it and do you anticipate it will be with the same syndicate, the same bank group that you currently have?

Kevin Mcaleer

Primarily, although there will likely be a couple of additions and a couple of subtractions. There have been a lot of changes in the banking environment in the last three years.

Ravi Chopra - Sandler Capital

Sure, and are you seeing any upward pressure on your other borrowings, your short-term bank loans? Are you seeing any upward pressure in terms of funds there?

Kevin McAleer

We certainly did in the fourth quarter, there were some premium rates at times, but we’re not currently seeing that.

Ravi Chopra - Sandler Capital

And what is your cost of funds there currently?

Philip Pendergraft

That’s actually a competitive issue that I’m not going to disclose, but it is based on fed funds. It’s a premium over fed funds.

Ravi Chopra - Sandler Capital

Okay and then I’m still a little confused on the Thinkorswim, if you could maybe just clarify for me. My current understanding is that TD Ameritrade is going to bring the clearing of options and equities onto their platform immediately post closing and then leave FX and futures with Penson. Is that right, and I guess what are the implications for economics for you guys in that situation?

Philip Pendergraft

I actually think that’s unclear. It’s our understanding that it will take them sometime to complete the integration necessary to convert all that business over and so that at least for this year, it will not have any revenue impact on us. Then on the futures and foreign exchange side, I mean we have work to do in terms of forging that relationship, but preliminarily we believe that we’re going to have the opportunity for a long-term relationship on the futures and FX side.

Ravi Chopra - Sandler Capital

Okay, so it’s just a matter on the options and equities, how long it takes for them to bring it onto their platform?

Philip Pendergraft

Yes, that’s correct.

Ravi Chopra - Sandler Capital

Okay and then the last thing, I just wanted to confirm your expectation for flat EPS. That’s off the adjusted number of $1.16?

Kevin McAleer

It is off the adjusted numbers, that’s correct. I think actually, when I’m talking about flat earnings. I’m talking about it more on an operating income basis. I don’t have an EPS number in front of me. We think we will be flat on a pro forma operating basis year-over-year.

Ravi Chopra - Sandler Capital

That’s a $29.5 million?

Kevin McAleer

No, the pretax number.

Ravi Chopra - Sandler Capital

The pretax number?

Kevin McAleer

Pretax of $40 million plus on a pro forma basis.

Operator

Your next question comes form Chris Donat - Sandler O’Neill.

Chris Donat - Sandler O’Neill

I just wanted to follow-up on Ravi’s question there. So because, I’m looking at the pro forma 2008 statement that was part of the earnings release and that’s got about $1.16 million, it’s got the $29.5 million of net income. So, Kevin and there is no pretax number there. So, I’m trying to make sure, I’m looking at the right or thinking about the right pro forma pretax. Kevin, you did just say that’s $40 million plus?

Kevin McAleer

Well, it’s approximately $45 million on a pro forma basis for ‘08. This is a net income number you’re looking at on the schedule attached.

Philip Pendergraft

That includes things like the tax rate adjustments. So --

Kevin McAleer

It includes SAMCO and it includes the Evergreen, the adjustment on the schedule to reported number.

Chris Donat - Sandler O’Neill

Okay, I see the SAMCO mentioned. I see the correspondent asset loss and then I guess the other little piece of the noise from this past quarter are not in there, like the FX and the taxes.

Kevin McAleer

That is correct.

Philip Pendergraft

That is true. When we look at 2009, what we’re essentially just looking at current exchange rates and not making any kind of forecast on exchange rate changes. We should point out that the $1.16 pro forma for 2008 is based on current share count and we would expect that share count would be modestly higher as option and RSUs --.

Chris Donat - Sandler O’Neil & Partners

Okay and then just on the expected tax rate going forward. Should we think about around 38%, which is what it had been?

Kevin McAleer

Yes, I wouldn’t change that at this time.

Operator

Your next question comes from Jeff Graph - Springhouse Capital.

Jeff Graph - Springhouse Capital

Hi, just want to clarify one thing you mentioned earlier. If you’re expecting to move $500 million to $1 billion into the federal Insured bank accounts and if you are successful in that move, then that’s what’s going to drive the potential 10 basis point spread improvement in the second half of ‘09. Did I get there right?

Kevin McAleer

Yes, that’s correct.

Philip Pendergraft

We are figuring interest rates can’t go any lower, so we don’t think we have a lot of downside exposure on interest, but we also don’t think they’re going to go higher this year, so we’re just trying to redeploy those assets.

Jeff Graph - Springhouse Capital

Okay and then, if you are successful in that, is there room for increasing the amount above $1 billion?

Philip Pendergraft

Sure. We set a near-term goal of getting up to $1 billion. If we are able to find enough institutions that will pay us a reasonable rate that has appropriate credit, I mean there’s no reason $1 billion has to be the limit.

Jeff Graph - Springhouse Capital

Okay, so assuming you are successful in finding a number of institutions. I mean, I am just trying to get a sense for what portion of the $4 billion that’s interest earning that you could potentially take it up to?

Philip Pendergraft

Well remember, we really only have a segregated balances in the $2.5 billion range.

Operator

There are no further questions at this time. I would like to turn the call back to Philip Pendergraft for closing remarks. Please proceed.

Philip Pendergraft

Well, thank you all of you for your questions and for your participation today. We really appreciate you joining us and we appreciate your interest in Penson. We hope to see some of you as we travel to meet investors later this quarter. We are scheduled to appear at the Raymond James Investor Conference in Florida on Monday, March 9, where we will be with Patrick; and then we look forward to chatting with you again when we report first quarter results in April.

On behalf of the Penson team around the world, we’d like to wish all of you a very good day and thank you for your interest and support of our company. Have a great day.

Operator

Thank you for your attendance in today’s conference. This concludes your presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Penson Worldwide Inc. Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts