FBR Capital Markets Corporation (FBCM) Q4 2008 Earnings Call February 25, 2009 9:00 AM ET
Shannon Small – Senior Vice President of Corporate Communications
Richard Hendrix – President and Chief Executive Officer
Eric Billings – Executive Chairman of the Board
Eric Bertrand – Barclays Capital
Good morning. My name is Natasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the FBR Capital Markets Fourth Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.
I would now like to turn the conference call over to Ms. Shannon Small, Senior Vice President of Corporate Communications.
Thank you, and good morning. This is Shannon Small, Senior Vice President of Corporate Communications for FBR Capital Markets. Before we begin this morning’s call, I would like to remind everyone that statements concerning future performance, developments, events, market forecasts, revenues, expenses, earnings, run rates and any other guidance on present or future periods constitute forward-looking statements. These forward-looking statements are subject to a number of factors, risks and uncertainties that might cause actual results to differ materially from stated expectations or current circumstances.
These factors include but are not limited to the effect of demand for public offerings, activity in the secondary securities markets, interest rates, the risks associated with merchant banking investments, the realization of gains and losses on principal investments, available technologies, competition for business and personnel, and general economic political and market conditions.
Additional information concerning these factors that could cause results to differ materially is contained in FBR Capital Markets annual report on Form 10-K and in quarterly reports on 10-Q.
I would now like to turn the call over to Rick Hendrix, President and Chief Executive Officer of FBR Capital Markets.
Thanks Shannon and good morning everyone. Lets begin today’s call with a review of 2008. First the numbers and then a summary of several key events. By now, most of you have the opportunity to read the press release. The results were impacted by several significant non-recurring items that I will touch on in a moment.
Our fourth quarter core operating loss on a non-GAAP basis was $21.8 million compared to $24.7 million for the fourth quarter of 2007, and $26.2 million in the third quarter of 2008. This measurement excludes specified non-core items and non-cash expenses, including $10.4 million in severance costs, and $66 million in net investment losses. The net investment losses in the fourth quarter includes $34 million of losses on mortgage-backed securities and $32 million of impairments and losses on other long-term investments.
As of early February 2009, we have sold all remaining MBS securities, recognizing a loss of approximately $1.5 million in the first quarter in order to eliminate any continued exposure to this asset class and we have retired all related debt.
Additionally, FBR Capital Markets recorded $25 million valuation allowance against deferred tax assets, which are reflected as income tax expense. The company expects to reverse this allowance in the future upon returning to profitability.
Turning now to revenues. Even in this most difficult environment, in 2008, we were able to grow our Institutional Brokerage business by more than 20%, to a record $138 million by focusing on providing valuable research and trading services to our institutional investors. Reflecting the extremely difficult state of the capital markets, investment-banking revenues were $97 million for the year, down 70% from 2007 levels.
During 2008, we added over 30 senior revenue generating professionals across the company, strengthening the overall depth of our platform. In response to the very difficult environment, we took a number of significant actions during the year that have all have to improve our operating leverage and position us for improved results in 2009. These included, reducing fixed expenses by approximately $45 million annually or 25%, reducing net headcount by 190 employees or 25%, and we closed unprofitable offices and scaled back international operations.
We also adjusted our variable expense structure to further reduce the overall level of break-even revenues. These actions have helped us to achieve an almost 50% reduction in revenue required to break-even. As a result, we ended 2009 with a significantly lower cost structure and a strong balance sheet, including over $200 million in cash. Furthermore, we have meaningfully reduced our risk profiles with the liquidation of the MBS portfolio, the recognition of significant write-downs at our merchant banking and other long-term investments and the retirement of all debt.
Additionally, through this period, we were able to add significant talent to strengthen our existing businesses and add new lines of business, which complement our full strengths. As we plan for the remainder of the 2009, it is abundantly clear that the economic downturn will be prolonged and the securities industry will continue to experience severe challenges.
We’ve set for three central priorities that will guide our actions this year. Specifically, our first priority is to preserve capital and maintain liquidity out of balance sheet. This is one of the reasons we took the actions related to the sale of the mortgage-backed securities described earlier.
In this challenging environment, it’s critical that we take such actions to mitigate potential risks to capital and maintain a strong balance sheet so that we emerge from this downturn and it position us strength with the ability to respond quickly to opportunities as they develop. Similarly, a continued focus on reducing cost will allow us to maintain high levels of liquidity and increase our positive operating leverage.
Secondly, we will work with our clients to help them achieve appropriate capitalization structures in this environment. As the access to capital becomes increasingly critical for the majority of small and mid cap companies, our investment banking team continues to be focused on building our pipeline of opportunities and it’s actively engaged with our clients many of them are poised to act quickly as soon as the markets allow.
Third, we will strengthen our organization. Specifically, we will continue to bring out experience revenue generating professionals in all areas of the firm, as well as augment and extend our current business lines with new products that add value for our clients. In the second half of 2008, we successfully integrated a new convertible securities team. This effort has already produced outstanding results expanding our institutional cap base and surpassing our earlier revenue targets.
We will use this model again in 2009 as we employ our significant liquid assets to broaden our product offering. For example through the addition of high yield and another products that complement our core trading and corporate finance franchise.
In conclusion, we believe FBR Capital Markets is very well positioned for whatever 2009 brings and we are committed to partnering with our clients to uncover every potential opportunities for them to access capital and enhance their businesses in this unprecedented environment. We will continue to focus on our own costs and the very prudent deployment of capital in the parts of the business where it can most effectively impact revenue growth.
In spite of the difficulty that this environment presents, our initiatives to reduce costs, eliminate risk, and add talented employees, that puts us in a much stronger position entering 2009 since any time in the recent past.
Lastly, I’d like to acknowledge Eric Billings and his recently announced retirement. As you know, Eric remains Chairman of the Board, even if he is now pursuing other interests and we look forward to his continuing contribution to our business development efforts. It goes without saying that FBR would not have the tremendous opportunities that are now in front of us without the leadership, vision, and relentless commitment of Eric over the last 20 years.
He, more than anyone else is responsible for the unique achievements that FBR Capital Markets over that time. His most significant achievement however, is on the building of what its today one of the best teams of professionals in our industry. A team that is entirely prepared to achieve even higher levels of success as we go forward. Because of Eric’s passion for the business, vision for the company's future, and commitment to it’s long-term success, we are positioned to navigate this difficult market and prosper as we capitalize on the inevitable opportunities now being created.
He has been a leader and mentor to many of our employees and we thank him for his immeasurable contributions in friendship, which we all look forward to continue. I’d now like to open the call for questions.
(Operator Instructions) You have a question or comment from the line of Eric Bertrand with Barclays Capital.
Eric Bertrand – Barclays Capital
The MBS portfolio, the $34 million loss isroughly 4% of the $850 million balance at the end of the third quarter. Could you help us understand how that actually generated losses? The understanding was that it was invested in agency MBS, which is mainly treasuries at this point. What’s the source of the loss? Was the decline in asset prices? Increasing funding costs on the Repo side? Was there a hedge issue? Help us understand that.
Sure Eric, good morning. We sold that portfolio, 50% was sold in the fourth quarter and the remaining 50% as I mentioned in the first quarter, but the $34 million loss in the fourth quarter was $23 million in realized losses that was a result of declines in asset prices. So, in this environment, even agency floaters which is what all these securities were, has declined materially in pricing and in fact, those securities that we sold had traded as low as the low 90s, 91 or 92, through different points in time in the fourth quarter. On average, we exited the portfolio about what you’re assuming kind of down 4 points on the $850 million. And so it was a 100% related to asset price declines. We averaged about an 85 basis point spread. So it was not as a result of increases in funding costs. And it was not related in anyway to hedging activity.
Eric Bertrand – Barclays Capital
Okay that’s definitely helpful. Then on the merchant banking portfolio, it looks like it was about a - almost a 50% loss on the portfolio during the fourth quarter, markets clearly down another leg during the first quarter, is it reasonable to assume another good chunk out, for example the (NYSE:XLS) down almost 40% since the New Year?
Eric, we feel comfortable where we marked the portfolio at the end of the fourth quarter, even with sort of a continuing declines in the overall market so far this year. We attempted to take a very, very critical eye to the portfolio and make sure that we did everything possible to, sort of put news and impact to the business from this part of our balance sheet behind us. We applied liquidity discounts to certain assets, despite where they might have been trading given sort of our overall level of ownership and sort of the relative liquidity in the market, which is, frankly a new approach for us. And so, we feel like even with these declines that we put that portfolio in a position where we hopefully are not talking about it again at the end of the first quarter
Eric Bertrand - Barclays Capital
If again read between the lines there, that’s basically saying that if we were to end the quarter today your, you would say that the merchant banking portfolio is not generating meaningful losses?
Eric Bertrand - Barclays Capital
Okay, fair enough. And then, ask one more question on the brokerage and then hop back in the queue. We’ve seen an anecdotal shift towards higher touch models given the stressed equity market environment. We would have thought that would actually accrue to you guys, particularly given the higher exchange volumes, during the quarter sequentially. Could you help us to understand why your commission volume and commission revenue was actually down 14% sequentially, the pricing mix, what's going on there?
You know it really Eric, if you sort of back go to the third and fourth quarters last year, there were big spikes in volume and sort of market share movements that occurred in and around the Lehman bankruptcy, and so there were huge spikes in volumes in the back half of the current quarter and that continued to some extent into October and we clearly benefited from. However, November and December were very, very light months for trading volumes and we’d sort of looked at the October activity as many of our clients getting to cash and they stayed very, very defensive kind of through the balance of the year. And so, November and December just had very, very light volumes. Despite the fact that we are confident when we look at overall exchange volumes and what's happening in the industry that we have taken share. So, despite the fact that there were, spikes in volume and there are big volume days out there. November and December for our whole industry were the lightest months from a trading standpoint I think any of us have seen.
Eric Bertrand - Barclays Capital
Okay. Then a follow-up on I think, so what’s the experience been in January and February? Have your clients started redeploying or they still kind of hunkered in?
Yeah, I would say that they’ve – they have begun modestly redeploying. I don’t think as a general statement, you can say that, cash that’s on the sidelines is reentering this market and that’s obviously a big part of why the market is down as much as this thus far. So, while we certainly have recovered volumes to beyond November and December levels. We know we are near back to where activity was in the late third quarter and early fourth quarter.
Eric Bertrand - Barclays Capital
Got it. Thanks. I’ll hop back in the queue.
At this time, there are no further questions or comments. Mr. Hendrix, do you have any closing remarks?
No I want to thank you everybody for joining us, and as always, we have a staff here that is happy to answer questions as follow-ups and we look forward to talking again next quarter. Thank you.
This concludes today's conference call. You may now disconnect.
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