Executives
Alan Oshiki - Investor Relations
John G. Duffy - Chairman and Chief Executive Officer
Robert Giambrone - Chief Financial and Administrative Officer
Analysts
Steve Stelmach - FBR Capital Markets
David Trone - Fox Pitt Kelton
Horst Hueniken - Thomas Weisel Partners
KBW, Inc. (KBW) Q4 2008 Earnings Call February 11, 2009 9:00 AM ET
Operator
Good day ladies and gentlemen, and welcome to the Fourth Quarter 2008 KBW Inc. Earnings Conference Call. My name is Erika and I'll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer sessions towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Mr. Alan Oshiki. You may proceed, sir.
Alan Oshiki
Thank you, operator, and good morning everyone. This is Alan Oshiki, KBW's Investor Relations contact. Joining us on the call this morning are John Duffy, Chairman and Chief Executive Officer of KBW; and Robert Giambrone, the Company's Chief Financial Officer.
Before we start, I want to briefly remind everyone that some of the statements made during this conference call constitute forward-looking statements within the meaning of the Federal Securities Laws. Including such statements are those regarding expectations and future results, general financial performance, future business prospects, and strategies. These statements are based on Management's current expectations and are subject to a number of risks and uncertainties which could cause actual results to differ materially from those described in the forward-looking statements. Investors are cautioned not to place undue reliance on these statements. Additional information about factors that could cause our results to differ materially from those in the forward-looking statements can be found in the company's filings with the US Securities and Exchange Commission.
At this time, I would like to turn the call over to Mr. John Duffy. John?
John G. Duffy
Thank you Alan, good morning to everyone and thank you for joining us this morning. 2008 was truly an extraordinary year and I think we're all happy it's behind us. Though we are very disappointed with the results for the quarter and the year, we are glad that we've come through this environment as well as we have.
There were really two major developments that impacted our results in 2008. First, the loss on trust preferred securities held in our warehouse and losses on CDOs resulted from the complete freeze-up in the credit and securitization markets. Secondly, the dramatic slowdown in the markets starting in September, following the collapse of Lehman and the turmoil at AIG and Merrill Lynch, and the resulting government intervention impacted our fourth quarter revenues. We firmly believe that our losses are behind us. We took some additional write-downs in Q4 as interest rates declined and the floating rate trust preferred securities that we held in warehouse depreciated in value because of their floating rate nature.
Fourth quarter results were also impacted by a drop in cash equity commissions and lower investment banking revenue. Capital markets revenue declined as investors went to the sidelines to assess the effects of government intervention in the financial services sector. We feel particularly well positioned to participate in the banking industry's recapitalization. The industry's needs are enormous, but we are uncertain as to how and when this free capital will be affected.
In light of the current environment, we are being much more aggressive on expenses that has been our habit to ensure our return to profitability. We have been selectively hiring talented personnel from firms and have been devastated by recent events but expect our headcount will be down for the year.
We have not changed our target comp to revenue ratio of 55 to 60% and we would expect that to be at the upper end of the range for 2009 given this difficult environment. At this point, I'd like to turn it over to Bob Giambrone, our CFO to go over the numbers in more detail. Bob?
Robert Giambrone
Thank you John, and good morning to everyone. As usual, I'll be discussing results on an operating basis. Our operating results are based on our GAAP results, adjusted for the amortization of one time restricted stock awards issued in connection with the initial public offering of our common stock which was completed in November of 2006.
First, I'd like to mention significant items for the fourth quarter and for the full year. As John mentioned, although we had significant principle transaction losses, core investment banking and cash equity's revenues were relatively strong given the very difficult environment for many financial services companies which constitute most of our customer base.
Equity commissions were a record $192.8 million for the full year, that's a $27 million increase or 16.3% from the net 2007 total of $165.8 million. This was in spite of lower commissions by European equity securities in the fourth quarter which were significantly impacted by a drop of over 50% in the value of shares traded, compared to the third quarter of '08.
Commissions on European equities are based on the value of transactions, not the number of shares. Commissions for the fourth quarter of 2008 were $39.9 million, compared to $45.9 million for the same period in '07. That's a decrease of $6.1 million or 13.3%.
Investment banking revenues for full year '08 were $163.7 million, compared to $226.5 million for 2007. That's a decrease of 27.7%, that reflects the difficult conditions throughout the year, and in particular in the fourth quarter. Equity and debt capital markets revenues for 2008, and that excludes structured finance were $88.8 million, compared to a $113.1 million for 2007, a decrease of $24.3 million. Principle transactions losses reflect the continued significant lack of liquidity and declining valuations of many securities markets and in particular the CDO market at the end of the year.
On the expense side, compensation expense decreased 12.1% for the year to a total of $214.9 million. Our capital which is all tangible, remains very strong and our balance sheet leverage remains relatively low at less than 1.5 times. Net loss for the fourth quarter was $20.2 million or $0.65 per diluted share, compared to a net loss of $21.3 million, $0.69 per diluted share for the third quarter.
Full year 2008 results were a net loss of $55.3 million or $1.79 per diluted share, compared to net income of $34.2 million or $1.08 per diluted share for '07.
I now would like to go over some selected items in a little more detail. First the revenue, investment banking revenues for the fourth quarter were $27.3 million, a decrease of $25.1 million from the fourth quarter of '07. M&A fees decreased $10.2 million to $11.3 million in the fourth quarter of '08, while capital markets revenues of $16 million decreased $14.9 million, compared to the fourth quarter of '07. Investment banking revenues for the full year '08 were $163.7 million, compared to $226.5 million in '07, a decrease of 27.7%.
Capital market's revenues for full year '08 were $87.4 million, compared to $140.4 million for '07, a decrease of $53 million or 37.8%, reflecting the fact in-part that two larger than average size and profitable PreTSL transactions closed in 2007 which had resulted in revenues of approximately $27 million in '07.
In 2008, we completed only two IPO transactions for customers, compared to fourteen for 2007. M&A and advisory fee revenues were $76.3 million for 2008, compared to $86 million for 2007, a decrease of $9.7 million or 11.3%. On the commission front, equity commissions for the fourth quarter 2008 decreased 13.3% to $39.9 million including $10.4 million on commissions for European equity securities. Commissions on European equity securities decreased 43.2% reflecting the more than 40% decline in the value of financial services stocks in Europe during the quarter. Equity commissions for 2008 increased 16.3% to a $192.8 million which included $63.5 million for European equities which compares to a $165.8 million and $65 million respectively for 2007.
Principal transactions resulted in a net loss for the year of... I'm sorry, for the quarter of $30 million as a result of further declines in the market value of equity and fixed income securities owned and investments. The unrealized losses were primarily on CDO and related securities all of which involves bank and insurance company trust preferreds.
The 2008 loss from principal transactions was a $143 million, which included over a $145 million in losses on securities and investments owned. Interest in dividends decreased 56.9% to $5.7 million and 34.4% with $12.9 million for the fourth quarter and full year '08 respectively. The reduced level of revenues from interest in dividends reflects lower levels of interest bearing assets as well as lower interest rates in 2008.
On the expense side, compensation benefits expense in the quarter decreased 29.2% compared to the fourth quarter of '07. For the year it decreased 12.1%. For full year '08, other expenses increased 1.6 million, or 6.9% due primarily to higher professional fees.
That really concludes my remarks and now I'm going to turn it back to John Duffy.
John G. Duffy
Thanks, Bob. Erika if you could queue up the questions, we'll respond to them.
Question-and-Answer Session
Operator
Yes, sir. (Operator Instructions). And your first question comes from the line of Steve Stelmach from FBR Capital Markets. You may proceed.
Steve Stelmach - FBR Capital Markets
Hi, good morning.
John Duffy
Good morning, Steve.
Steve Stelmach - FBR Capital Markets
John, just a couple of quick questions, first on the investment banking side. When you are talking to issuers, what are you looking for in terms of point to trigger and on capital rate, is it simply an issue of, hoping for a better valuation somewhere down the road or do they need sort of more definitive plan from the government, what's sort of low jamming (ph) your mind?
John Duffy
Good question. I think what happened in the fall with the announcement of TARP almost all the issuers kind of went to the sidelines and evaluated whether the capital of systems program made sense for them, obviously, hundreds of them avail themselves to that. And the view I think generally was that that capital was cheaper than they could raise in the public or private markets. So, I think that really in effect for several months put a lot of our discussions with issuers really on hold. I think since the first of the year, discussion levels or discussions have kind of rekindled the valuations though, especially in the regional bank sector, have been hammered pretty hard. And I think there is a period of adjustment here, where some managements are a little struck by whether stocks are trading. And I was in discussion with them about their options. I think at the moment, that is largely the private equity space. Private equity community wants a more senior position than straight common or preference. So there is, in some cases I think there is resistance to that. But I think the longer this environment exists, the more that there will be capitulation on the part of banks or potential issuers that the Government's forcing them to go get that capital and I think the capital out in the public or private markets is maybe more appealing than the terms attached on the latest government plan, so.
Steve Stelmach - FBR Capital Markets
Okay.
John Duffy
I think we're looking at this day by day depending upon who you talk to, there are different attitudes. So, I think as fair to generalize, but clearly the very pressing need for capital isn't going away. It's just a question of how that capital was raised.
Steve Stelmach - FBR Capital Markets
Yeah. And I realized it's only been a day since and Geitner's disclosure yesterday, but what's your feel for that? As in a lot of examples, some of these banks are trading at 20% lower than the February 9 close which is where they can get government capital. What's your feel in terms of this new proposal? Is it sort of delay yet again, private capital entering the market or is it sort of clearing the log ham a little bit?
John Duffy
I think it may clear a little bit. Clearly, the market didn't like it and didn't do anything good for bank valuations. But I think a lot of banks tried to bolster the reserves in the fourth quarter, getting more aggressive on charge-offs, greater recognition that there were problems in the commercial real estate space. So, I think we're seeing while there is still certainly some managements in denial about the situation or predicament that they are in. Gradually that there are more and more banks understanding the medicine is going to be pretty though, but they are not going to get well without it.
Steve Stelmach - FBR Capital Markets
Right.
John Duffy
The government plan I think still has kind of a lot of questions. We can probably spend the rest of the morning talking about what Washington is doing right or wrong. My feeling is there got to be acknowledgement that they've got to lend real estates prices fall, there isn't any magic bullet to prop-up the housing market, it's become a... in my eyes it's become kind of a political football. When commercial property owners take a hit, because they lend too much money or lenders lend too much money against a particular property, there is not a lot of angst in part of Congress, but because this is their constituency that's suffering significant loss in their primary residence and so it has become a political issue. And I mean we've just got to let housing prices continue to drop, clear the market and get the economy growing. That's what's going to clear the housing market and some of these plans that have been talked about or proposed, I think are excellent (inaudible).
Steve Stelmach - FBR Capital Markets
Yeah, I would agree. And then just lastly, and maybe I'll hop back in queue. On the commission side, you mentioned obviously the European commissions were down based on the value their underlying securities, in absence of recovery, are you guys doing anything over in Europe to bolster production, are you hiring more people or maybe upgrading? Or are you implementing (ph) cost savings note over there?
John Duffy
I think it's got a status quo over there. Clearly, the levels are down given the prices. There is going to be recaps over there. So, we don't want to have anything, a dramatic reduction in size over there, because I think there is opportunity for us to pick up market share and there is going to be capital raised, in fact this week, I think there were already two rights offerings announced in Sweden.
So there is activity over there. We think what we saw there in November and December might be the low watermark. We are not expecting we're going to get back to the levels we got back to before, because prices aren't. But actually in terms of shares traded, we're still pretty busy, it's just the value of those shares is down fairly dramatically and you charge over there on basis points not on a fixed cents per share.
Steve Stelmach - FBR Capital Markets
Yeah. Okay. And then so one last question for Bob. On the comp side, and pardon me if I missed it, the lower comp in the fourth quarter, was there anything abnormal in there, was there like a true-up of accrued bonus or anything in the fourth quarter that made the comp to drop quarter-over-quarter?
Robert Giambrone
Yeah. Well I think the big adjustment in the fourth quarter was on the bonus line, it was nothing else.
Steve Stelmach - FBR Capital Markets
Okay. So maybe second quarter, third quarter, more of a run-rate going forward?
Robert Giambrone
I would think so, yeah. I think the fourth quarter revenues were not what we expected and it resulted in a lower bonus accrual.
Steve Stelmach - FBR Capital Markets
Got it. Okay.
John Duffy
And Steve, we felt like we've got to get the comp revenue line at 60 or lower to generate a reasonable level of profitability. So, that's the goal going into '09. So, I think you're right, don't look at the fourth quarter is kind of the norm.
Steve Stelmach - FBR Capital Markets
Yeah. Okay. Thank you, guys.
John Duffy
Okay. Thank you.
Operator
Your next question comes from the line of David Trone from Fox Pitt. You may proceed.
David Trone - Fox Pitt Kelton
Hi, good morning guys. My questions were answered but I did want to clean-up a couple of the numbers. I think you gave the 10.4 million European commissions for 4Q?
Robert Giambrone
Yeah.
David Trone - Fox Pitt Kelton
Is that right? What was the 4Q '07 number?
Robert Giambrone
I believe that it was 18 million.
David Trone - Fox Pitt Kelton
Okay. Great. And these are... refresh my memory, because I'm at the office, these are all just pure secondary, right?
John Duffy
Yeah.
Robert Giambrone
Yeah.
John Duffy
The European Commission will be pure secondary.
Robert Giambrone
Yeah, all secondary.
David Trone - Fox Pitt Kelton
Okay. And the... so that's a segue. On the investment banking side, that's probably, what 90, 95% U.S.?
Robert Giambrone
I'm sorry 90, 95% what?
David Trone - Fox Pitt Kelton
Like, there's not really been a lot of action in your European revenues on the investment banking side, is that right?
Robert Giambrone
Well there was... there were transactions last year, we did have revenues. I don't really have a separate number for that. But there was at least one M&A transaction, yeah, it would be between 80 and 90%, David, not between 90 and 100.
David Trone - Fox Pitt Kelton
Okay. Sounds good. And I think that's pretty much everything I had. Thank you, very much.
Robert Giambrone
Thank you, David.
Operator
Your next question comes from the line of Horst Hueniken from Thomas Weisel Partners. You may proceed.
Horst Hueniken - Thomas Weisel Partners
Good morning.
John Duffy
Good morning, Horst.
Horst Hueniken - Thomas Weisel Partners
Bob, I just wanted to clarify something, you have in your press release that the inventory write-downs were approximately 24 million, yet your total principal trading loss was closer to 30, which leaves me wondering what the 6 million was about. Is that related to facilitation losses or what?
Robert Giambrone
Well, it's a... that's a big net number, because principal transactions includes basically a number of customer facilitation businesses or cash fixed income business and some small amount of equity proprietary trading market making. That's one big net number. And...
John Duffy
We've also wrote down some private equity investments both in partnerships and individual securities in the fourth quarter that really came from the drop in the equity markets in the fourth quarter. We really have much of that for the first nine months.
Horst Hueniken - Thomas Weisel Partners
Okay. Alright, that's good. We have seen a few dealers change their accounting for restricted stock options and units, you have chosen it appears, not to go that route. Was that something you considered and rejected or didn't even consider?
John Duffy
I would say we didn't really consider it, we've read the other releases, it looks like they've removed some restrictions to change the accounting. We feel the plans that we adopted when went public and when we started to pay part of our bonuses of stock still makes sense. I think if we... the compensation committee has an outside consultant they use in terms of helping us devise plans. If someone came to us and suggested what we had wasn't working, I think we'd be open to, we're not bound to these. But we think the plans that we have in place, are working and helping us achieve the desired result in terms of retention, employee retention and things like that.
Horst Hueniken - Thomas Weisel Partners
So based on the manner in which you compensated last year which included stock as well as cash or bonuses, one can expect that that's the method by which you will compensate going forward as well, correct?
John Duffy
Yeah, in fact we just paid our '08 bonuses within the past weekend and there was a stock component to that, to those bonuses for individuals that had a compensation level among other certain (ph) number.
Horst Hueniken - Thomas Weisel Partners
Got it, understood. And just one point of clarification, John, you mentioned that you expect the headcount will be down for the year, are you referring to 2009?
John Duffy
Yes.
Horst Hueniken - Thomas Weisel Partners
Alright, and finally, this is just for the clarification on this Timothy Geitner discussion, you've already addressed what you would need to see, but I just wanted to recap my understanding of what are the signs that you need to see to convince yourself that demand for KBW services is about to pick up? What I am hearing I guess is from your perspective is you need to see the CEOs sort of capitulate and either accept their low valuation levels and perhaps we need a little more clarity from the Government and with that point that one can expect things to get moving, is that?
John Duffy
I think that's right. It will also help obviously from the investor perspective, if they felt we were at... are near the bottom.
Horst Hueniken - Thomas Weisel Partners
Right.
John Duffy
Since well as a lot of money out in the private equity community. I would characterize some of that money is being interested, but not necessarily ready to pull the trigger. They are trying to figure out where they want to spend that money, but depending upon the valuation and how close they think we are to reaching a bottom, we'll dictate whether they are really ready to sign a check. I think there are people all over that spectrum. And I think the consensus is, we're not at the bottom, there is more pain, but these valuations have been hammered down to levels that I think there is a fair amount of interest on the part of the private equity community.
Horst Hueniken - Thomas Weisel Partners
So, in the last conference call, you mentioned that you were in discussions with hundred plus issuers. Is that still the number?
John Duffy
No, I would say it's less. I think some people that might have been looking at the capital markets, was just better (ph) than the first program of sort of capital assistance and have probably fulfilled at least part of their needs if not all. I think they are great, many people still very interested and probably some new ones inline looking at their capital needs and feeling that they probably need more than they fell back in the early fall. And unfortunately, there are probably one or two banks that we were talking to, two banks that haven't made it this far.
So, I think net... the number is down. Some of that is that there are people on the sideline, that are still trying to figure out what the whole government intervention program and whether the next round of TARP is feasible for them or whether they want to go to the public markets.
Horst Hueniken - Thomas Weisel Partners
That's a great insight. I wish I had a clear crystal ball. Anyway that's all for me. Thanks.
John Duffy
Thank you, Horst.
Operator
(Operator Instructions). And your next question comes from the line of Simon Craig (ph) from Newton. You may proceed.
Unidentified Analyst
Hi, there. Thanks, all my questions have been answered. Thank you.
John Duffy
Thank you.
Operator
And this concludes the question and answer portion of the call. I will now like to turn it over to Mr. John Duffy for closing remarks.
John Duffy
Thank you Erika. Thanks to all for participating. We plan on not doing another call until after the second quarter, but as we did after the third quarter, if there are extraordinary events, we may change our mind. But we appreciate your interest in the stock and thank you for dialing in this morning. That will conclude. Thanks. Thank you, Erika.
Operator
Thank you, sir. Thank you for your participation. You may now disconnect and have a wonderful day.
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