Fortress Investment Group LLC Q4 2008 Earnings Call Transcript

|
 |  About: Fortress Investment Group LLC (FIG)
by: SA Transcripts

Fortress Investment Group LLC (NYSE:FIG)

Q4 2008 Earnings Call

March 16, 2009 10:00 am ET

Executives

Lilly Donahue – Managing Director, Investor Relations

Wesley Edens – Chairman and Chief Executive Officer

Daniel Bass – Chief Financial Officer

Peter Briger – President and Head of Hybrid Hedge Fund Business

Mike Novogratz – President and Head of Liquid Markets Business

Randal Nardone – Chief Operating Officer.

Analysts

Roger Freeman – Barclays Capital

Marc Irizarry – Goldman Sachs

Unidentified Analyst

Roger Smith – Fox-Pitt Kelton

Robert Lee – KBW

Operator

Welcome to the Fortress fourth quarter and year-end earnings conference call. (Operator Instructions) I would now like to turn the conference over to Lilly Donahue.

Lilly Donahue

I would like to welcome all of you to our fourth quarter and full-year 2008 earnings conference call. Joining me today is Wes Edens, our Chairman and CEO; Dan Bass, our Chief Financial Officer, and we also have Pete Briger, President and head of our Hybrid Hedge Fund business; Mike Novogratz, President and head of our Liquid Markets business, and Randy, our Chief Operating Officer.

I do want to take a minute to point out that statements today which are not historical facts may be forward-looking statements. Our actual results may differ materially from the estimates or expectations in any forward-looking statements. These statements represent the company's beliefs regarding events that by their nature are uncertain and outside of our control. I would encourage you to review the forward-looking statement disclaimer in our quarterly earnings release, including the recommendation to review the risk factors that are in our annual and quarterly reports that are filed with the SEC.

Now with that, I would like to turn it over to Wes Edens.

Wesley Edens

Thanks for taking the time to join us this morning for our fourth-quarter and full-year 2008 conference call. 2008 was obviously the single-most volatile and difficult year in the financial markets at any point since we’ve been alive, and the volatility has continued here in the first quarter. The stock market has had its worst start to a year since they began keeping records over 100 years ago, and the credit markets continue to be very challenged. Credit continues to be significantly constrained. Housing prices continue to decline. Unemployment is rising. Markets and economies are very difficult, not only here but throughout the world.

These tremendous dislocations, while violent and unnerving to us all, are of course, exactly the types of markets that produce "once-in-a-lifetime" investment opportunities. We at Fortress believe that we are very well-positioned to weather these stormy markets, as well as to be able to take advantage of opportunities as the markets stabilize. Approximately 82% of the capital of the firm is long-term private equity capital with an average 9.2 years of remaining term, and we have several billion of uncommitted dry powder to pursue investments in both private equity and credit.

Dan Bass, our CFO, will walk through our financial results in greater detail in a few minutes, but in a nutshell they are highlighted by consistent cash flows from our management fees and core operations but offset by lower performance in hedge funds and the non-cash write-down/impairments in our private equity fund investments.

In short, we earned segment management fees of $147 million for the quarter and $598 million for the year, up 27% from a year ago. However, our distributable earnings were negatively impacted by non-cash adjustments from a combination of write-downs on principal investments, as well as a reversal of incentive income earned under private equity funds stemming from these unrealized write-downs or clawbacks as they are commonly known.

It is important to point out that these reserves for impairment on our investments do not represent a permanent loss in value. They’re being marked in accordance with FASB 157, which compels firms to estimate market values as if they are to be liquidated today, which of course we have no intention of doing so. Investment results in our private equity funds will be based on ultimate realizations in those funds, in most cases a number of years in the future.

The write-downs are disappointing and something you’ve seen in virtually every sector in the investment business. We’re long-term investors with patient capital, and although disappointed, we’re very focused on underlying investment performance and long-term returns.

Importantly from a balance sheet and liquidity perspective, we are pleased to report that we recently completed an amendment to our bank facility for our lenders that both deleverages the balance sheet, as well as relaxes several our financial covenants, in particular our asset covenants. We were in full compliance with our existing debt in all regards, but we are very focused on reducing our exposure to those things out of our control. By working collaboratively with the lenders, we are able to reduce our asset test by approximately $300 million without a material increase in our interest rate. Dan will walk through the specific changes, but this is an excellent result for all and something we are very happy about.

Now let's talk about each of the major business segments—macro, credit and private equity. Our macro business is two primary businesses – a core multi-strategy fund of $4.8 billion after the redemptions are paid in February. It is run on a day to day basis by Mike Novogratz and Adam Levenson, and we have a commodity-based hedge fund of $1.1 billion run out of London by Bill Callanan. The macro business had its first negative returns last year in its history. Launched in 2002 they have been profitable every year. On average they have earned approximately 14% with the lowest year being last year at negative 22% net returns, a tough year but pretty much in line with most of the hedge fund community. However, the tremendous volatility in the marketplace creates excellent opportunities for a macro fund, and we’ve had a very solid positive start to the year thus far.

As a business, we have greatly reduced the number of portfolio managers, focusing our risk and capital deployment directly around Adam, Mike, and a handful of others, which we think makes a tremendous amount of sense and has yielded positive results thus far. The fund has been positive in each of the first two months of the year and is positive thus far in March.

Our commodity business had a very good year last year, earning just under 7% on a net basis, which is particularly notable given the tremendous sell-off in the commodities indexes across the world. They are also off to a good start this year, positive through March, and continue to attract capital and grow their business.

Moving on to credit, last year was the worst year for the credit market since we’ve been around, and with the seizing up of the world's credit markets, particularly in the fourth quarter, there was a tremendous amount of value destruction that occurred at every level. The degree to which the value diminution represents the true loss of value versus mark-to-market values, which have been greatly impacted by the severe lack of liquidity remains to be seen. But one thing is certain. There was a tremendous amount of money lost in the credit markets last year.

Our core fund run by Pete Briger had its first down year in its existence. For the year the special opportunities fund was down 26%. Just as was the case with the macro, our credit business has been positive in every year it’s been in existence, and as is the case with the macro funds, the fund is off to a very good start this year, having had its most positive month ever in January and positive results in February as well.

Capital structure for the credit business is tremendously important, and the bulk of the credit funds' liabilities are long-term, non-mark-to-market, non-callable facilities. There is still a significant amount of dry powder in these facilities. Pete has always been focused on asset liability management, and although none too happy about mark-to-market performance of the funds, in the end, so long as your capital is patient long-term as it is here, the ultimate value of the investments will become evident. This is the one business that had a significant amount of capital formation late last year, and I will touch on it in a minute when I talk about capital formation for the firm overall.

Private equity also suffered significant mark-to-market losses in the fourth quarter and for the year. For the most part in private equity, we have been duly focused on liquidity and financings of the portfolio companies, as well as our core operational performance in the midst of a difficult economy.

Well over a year ago, we became very focused on liquidity in our portfolio of companies, and although much of our debt is long-term in nature, we had some debt that was due in the short-term and needed to be rolled out or refinanced. Much of what we needed to get done was accomplished in the first half of the year, and as time went on and the credit crisis intensified, we continued to have success in getting our debt refinanced but with increasing degrees of difficulty. In the end we had a tool of approximately $7.2 billion of our debt that rolled last year; 100% of it was refinanced successfully. This year the total amount we're working on is considerably less than that, and thus far through the first quarter, we’ve continued to check things off the list.

As the year went on, the economic crisis shifted from a liquidity or financing crisis to a more direct operating crisis. Given the conditions, the prescription for virtually every business in America is the same. If you're worried about your access to finance, you need to conserve your capital and limit your growth plans, which is a negative feedback loop that the markets have had for the past year or so.

Our core investments or asset-based—senior living, apartments, railroads, etc., and by design tend to be typified by stable and recurring cash flows, but very few businesses are truly recession proof. We have been working closely with our portfolio of companies on managing liquidity, financing and costs and with few exceptions feel great about the results that they have produced. I believe that once the markets stabilize, there will be many excellent opportunities to grow and invest in our businesses.

Capital formation for the year was net positive, in spite of the tremendous headwinds that the markets faced. In particular, in the fourth quarter, we had the final closing on approximately $3 billion of capital and credit. Even in difficult markets, investors recognize the great opportunities in credit, and to the extent that they are in the position to allocate fresh capital to the area, credit is high if not at the top of the list.

Hedge funds as an industry are not dead. To the contrary, I believe they’ll be a much bigger industry five years from now, but the form of the industry is changing rapidly. With the risk of financial frauds of Madoff and the like, we think you’ll see significant growth in separate accounts, something we have already seen, and a move from large, multi-strategy funds to more focused, targeted funds. Best-in-class managers will and still are attracting significant capital.

If this is the great recession of our lifetimes, then surely what will follow will be the great liquidation, first and foremost by financial institutions, banks, insurance companies and the like shedding "toxic assets" and then followed by the government. There are approximately 8300 banking institutions today, and we believe the consolidation of the banking sector will be significant and yield sizable opportunities. We're currently working on a number of initiatives here and believe this is an area that holds tremendous promise. You have undoubtedly heard many RTC comparisons over the past year in terms of the types of opportunities. Those are great times to invest in financial assets. In between Pete and myself, we're among the most active investors of that time.

What is so different this time around is just the sheer scale of this, not just in the US but around the world. The past year was a very difficult one for everyone involved in the markets, and virtually anything you invested in was bought too soon. The only safe place for capital was short or on the sidelines.

The government has made an enormous effort thus far to restore stability to the banking system and restart basic operability of the financing markets through TALF and other measures. I'm a big believer in the impact that TALF can and should have, in particular to the extent that the financing is used to fund both new credit originations as it will initially, but also as contemplated to fund existing legacy assets critical to the path to recovery to restore some stability to the asset prices and providing the market financing for new capital to come in and buy assets as an essential step.

The market worries about asset deflation, and the government is resolved to follow these financing programs through to their completion without disrupting basic market principles. The building blocks they have highlighted of, one, stabilizing the financial system, two, fixing the mortgage and foreclosure mess, and three, restarting the financing markets are principles we strongly believe are the right ones. It’s now to be seen as to the effectiveness of converting those good intentions into practical application. TALF and the soon-to-be-announced financial service reforms and public-private partnerships are huge incremental steps and something we’re very optimistic about.

The year 2009 will undoubtedly be a very challenging year as we expect to see continuing volatility in the financial markets. That said, we're working hard every day to be nimble to respond to our ever-changing economic, political, and in some cases legal landscape. Our core macro and credit businesses are at the nexus of where we see the opportunities this year. We look forward to sharing with you our thoughts as the year goes by. Thank you for the opportunity.

With that, let me pass this over to Dan.

Daniel Bass

Good morning, everyone. Now I will provide you with additional information regarding our fourth-quarter and year-end results. Assets under management ended the fourth quarter at $29.5 billion, which is down 11% from a year ago. The decline in AUM from the year-end 2007 resulted mainly from changes in accounting value of estimates in our funds. To remind everybody, our AUM figure is defined as our fee-generating assets under management. In the case of our funds where carrying values of fund investments declined, so did our AUM. Consequently if asset values rise from current levels, our AUM would increase.

From a capital flow perspective, in 2008 we raised net capital of $5.8 billion comprised of $8.7 billion of gross capital raised, less redemptions of $2.9 billion. If you take into consideration the redemptions in our Global Macro Fund that no longer paid fees beginning at January 2009, our AUM would approximately be $27.1 billion. In addition at year-end, we had approximately $1.7 billion of undrawn fee-paying capital. It is important to reiterate that 82% of our AUM today is long-term private equity style capital.

As for performance, although we're disappointed in our results, the most significant factors that negatively impacted our full-year pretax DE were reserves taken in 2008. First, a reversal of incentive income in our private equity funds, as Wes mentioned, and second, impairments we had at the corporate level investing alongside our limited partners in our private equity funds.

Specifically the numbers for 2008, we had a pretax DE loss of $162 million for the year compared to pretax DE gain of $552 million in 2007. The $162 million pretax DE loss was comprised of $216 million of fund management DE and a $378 million loss on our principal investments. The $216 million of fund management DE included an $81 million net reserve for the potential clawback of previously recognized incentive income from our private equity funds, and the $378 million loss on our principal investments included $287 million reserve for other than temporary impairment on private equity investments, $51 million of mark-to-market losses from our hedge fund investments, and $40 million of interest carrying costs. The reserves taken during the quarter equalled $299 million, made up of a $71 million clawback reserve and $228 million of impairments on our investments.

With respect to our balance sheet, as of 12/31/08, we had cash of $263 million, approximately $750 million in investments, and bank debt of $729 million. As Wes mentioned, we were in compliance with all of our financing covenants at year-end. However, with continued stress and turmoil in the financial markets, we felt that it would be prudent to amend our credit agreement in order to give us more operational flexibility. As a result, we amended our credit agreement where we paid down the balance to approximately $600 million in exchange for significant covenant relief. We also modified the scheduled amortization, and the rate was modestly stepped-up by 50 basis points to LIBOR plus 250 from LIBOR plus 200.

The revisions to our financial covenants are as follows: The EBITDA leverage test where EBITDA approximates fund management DE, excluding clawback reserves, has been increased to 3.5 times until maturity at May 2012, up from the previous 2.75 times and stepping down to 2.25. To meet this throughout 2009, we need to maintain a quarterly minimum run-rate of $35 million of EBITDA. To give some context, our 2008 run-rate was approximately $79 million per quarter.

In addition, as Wes mentioned, our assets coverage test has been changed to one times outstanding debt or $600 million today. After this amendment, the total capacity of our credit facility is approximately $610 million. Getting this amendment closed in this market environment reflects our solid working relationships with our banks, and we think it’s a positive result for all of us.

Finally, with respect to our $750 million of principal investments, at year-end, we had approximately $560 million in private equity investments and $190 million in our hedge funds. Although we took an impairment on our PE investments, they are mostly unrealized, and we are long-term investors, and we're very focused on the underlying forward investment performance. These markets continue to be challenging, and we are focused on improving all aspects of our business. Not only are we highly focused on managing our investments and raising capital where we see opportunities, but also in cost-saving measures that make sense in improving our organization and our financial results.

With that, I’d like to now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Roger Freeman with Barclays Capital.

Roger Freeman – Barclays Capital

To come back quickly to the revised covenants, there are no minimum AUM requirements on the new facility?

Daniel Bass

No, there is. That is $22 billion, stepping down to $20 billion at the end of this year.

Roger Freeman – Barclays Capital

And that is the only stepdown?

Daniel Bass

Yes.

Roger Freeman – Barclays Capital

Can you just remind us in terms of debt coming due this year on your portfolio of companies, you had a slide up last time which probably has not changed much, but I think there were two concentrated ones, as I recall $1.6 billion for one company and 723 for another. When in during the year do those come due, and what are the circumstances going to be around that?

Wesley Edens

Roger, we actually had some significant financing that was due in the first part of this year that has been paid down and already resolved. We have got large financings that are due at the end of July and then a paydown in October that we’re in discussion on both of them right now. It is a far cry from the debt activity of last year, and then post this year, there is really very little in the way of real debt that is due now until 2012 and later. Getting any piece of financing done in this market is challenging, but it has been very constructive thus far. We have made good progress, and as I said, we just continue to check things off the list.

Roger Freeman – Barclays Capital

Are these situations that are potentially analogous to say Intrawest last year where you get modifications done to the terms of the refinancing in order to avoid any kind of default scenario?

Wesley Edens

Well, it is obviously very case specific, but as a rule, we have used modest amounts of leverage at the time we made acquisitions, and so that obviously is a big plus and we have asset-based businesses. I think the cornerstone to a lot of these transactions is to be able to take a large financing and break it into smaller constituent pieces that you can then attack one by one. That has been successful for us to date, and I think it is going to be the case in a number of these situations going forward.

Roger Freeman – Barclays Capital

Around the claw-back, can you help us think about that one a little bit? Is this one fund where your auditors are saying that there is reasonable likelihood that you don't exceed the hurdle rate over time, and what is the duration on that fund?

Daniel Bass

The funds' durations are four to six or seven years out, and it’s basically rising to a level of greater than remote. So it's a small probability, but we have taken the reserve that it is greater than remote, so that was really our analysis. It’s a pretty low bar.

Roger Freeman – Barclays Capital

To the extent that we get a rally in the market and you take a more favorable view of those marks, can you start to reverse that? What is the threshold to be able to start to essentially take that claw-back away again?

Daniel Bass

There would have to be significant rallies, but as a general matter, you can reverse the reserves.

Roger Freeman – Barclays Capital

In terms of your own principal marks, I tried to do some math here and maybe it is right, maybe it is not, but it looks like you took about a 27% hit on total investments across your private equity and hedge funds, but your private equity funds are marked down I think like 18%. It looks like 8% in liquids, 21% in hybrids. So it looks like your own investments were marked more. iIs that just a function of where your concentrations were?

Daniel Bass

It is absolutely concentration-specific. Our balance sheet is slightly different than the overall private equity business.

Roger Freeman – Barclays Capital

Within the hybrid, it looks like there was only about $12 million in new capital that came in during the fourth quarter. Is that right? I'm trying to think about the fund raising around distressed opportunities that you're talking about obviously having a lot of them. Is it easy, or are you able to raise these funds right now?

Daniel Bass

Yes. I think it just has to do with the segments in which the funds are located. The capital that we closed that Wes referenced in October was private equity capital, 10-year life for most of it and five-year life for a small piece of it, and so it is not actually in the hybrid segment. It’s in the private equity segment.

Roger Freeman – Barclays Capital

Wes, you talked a little bit about TALF. Do you look at this as a reasonable opportunity for Fortress given some of the pretty attractive returns that might be able to be gotten here given the huge leverage that the government is going to provide? Also are you looking at this potential public-private partnership? Blackstone has said they had conversations with the government about it. They were interested in if the terms were attractive. Do you feel the same way? With TALF and to your point about maybe taking on legacy assets over time, if they can’t get that together, do you think TALF maybe picks up that role?

Wesley Edens

I do believe that TALF can play a very material role in both stabilizing asset prices as well as restarting primary levels of finance. There is schedule to have the first drawdown of the facility this week, and I think that success in that in really any dimension will be a real step forward in terms of the marketplace. We have actually had very active dialogue with the government at a number of different levels regarding their initiatives with respect to TALF and financing and legacy assets and the like. I think they are very focused on two objectives. One is to provide primary level of finance, and they are starting with obviously credit cards and student loans and auto loans, but I think they're rapidly considering expanding into other types of legacy assets—CMBS, RMBS, servicing advancements, there is a whole litany of things that they are considering.

I think what the form of the ultimate public-private partnerships is and whether they are TALF, son of TALF, nephew of TALF, or they’re different elements of that, or they are just direct RTC-like end series private partnerships or something altogether different, all of those are aimed at trying to restart private capital flows into the marketplace, and I think that they represent a tremendous opportunity for investors. Really the lack of long-term committed non-callable capital has been at the center of some of the asset price declines. I think that reversing that and having the government play an active role in that is something that is both appropriate and will be a huge thing, again conditioned upon it being something which is actionable and effective and is able to get in the marketplace and be accessed by people readily.

Roger Freeman – Barclays Capital

Do you plan to participate in this first round of financing?

Wesley Edens

We do. We are very supportive of it. When you take the perspective of the Fed where their primary financing operations historically were financing treasuries and now they are talking about financing receivables and the like and then legacy assets, it’s a complex step to make. They have got a lot of very talented people that we have talked with, and I think they are hard at work trying to actionalize this, so we are very supportive of it.

Operator

Your next question comes from the line of Marc Irizarry of Goldman Sachs.

Marc Irizarry – Goldman Sachs

Dan, can you just go back to the EBITDA coverage test again? You mentioned that last year that number was $79 million per quarter. Can you give what the like number was for the fourth quarter of this year?

Daniel Bass

Yes, the like number for the fourth quarter this year was probably around $73 million. It was pretty consistent throughout the year.

Marc Irizarry – Goldman Sachs

How about for the asset test? Can you just tell us what that covenant is? Wes mentioned it was a few hundred million?

Daniel Bass

It is one time outstanding total debt, so it’s $600 million, and prior to the amendment, it was $925 million.

Marc Irizarry – Goldman Sachs

What is the maximum amount of claw-back that would be run through distributable earnings if assuming that in a catastrophe scenario that you needed to liquidate all the investments?

Daniel Bass

The maximum claw-back amount, roughly an additional $60 million on a net basis would be the number if we got zero from the investments that we have taken reserves on today.

Marc Irizarry – Goldman Sachs

Wes, if you can talk a little bit about or just flush out your comments regarding the future of the hedge fund business. You mentioned that it seems like if LPs are likely or investors are likely to pick more focused funds over maybe more multi-strategy funds. How does the macro strategy play into that fund formation and flow prognosis, if you will, and then also what do you plan to do with the Fortress hedge fund business? Are you going to try and launch more targeted strategies going forward, or how do you thinking about capital formation there?

Wesley Edens

It is very clear to us that there is a real move afoot to provide great levels of transparency and focus to people that are investors in the hedge fund space. So while there has been negative capital flows and negative performance for the industry as a whole, we have seen and have had very active dialogues with people that are just very focused on having a separate account set up. It’s operationally perhaps more intense for firms like ours, although we're clearly capable of doing so, but people want to see in these difficult times, especially where there has been fraud and there has been misconduct, that they can see clearly what they own and how they own it. What that really means I think in large part is that this is going to be a consolidation among the biggest players only. It’s not that all small hedge funds will go away, but the operational demands of administering this are significant, and there is a big focus on people's hearts of being able to see again clearly and transparently what it is that you are actually investing in and how things are really going with it.

With respect to our own macro businesses, with Adam and with Mike, we have two of the most talented people in the macro business. They’ve had terrific returns over the years. Their fund performance last year, while it’s a negative and is a disappointment, was very much in line with aggregate returns to the hedge fund industry. We have taken down substantially the number of managers that we had to concentrate the risk and the capital commitment between Mike and Adam and a handful of others, and I think you're going to see the same thing broadly speaking in the industry where people are going to become very focused. I think the best-in-class operators will attract capital. So I think while this is a significant restructuring in terms of what the industry has gone through over the past year or so, it is not the death of the hedge fund industry. I think to the contrary, I do believe it will be a much bigger industry at the end of the day. If we go into a period where you have really trading ranges similar to what happened in Japan for the past 10 or 15 years in the equity markets and there is a lot of volatility but absolute returns are modest, then I think absolute return products like hedge funds become even more attractive. We have seen very positive results this year, and we're optimistic that it is a sign of things to come.

Marc Irizarry – Goldman Sachs

Can you talk a little bit about the dry powder? Just break it out between private equity and maybe, Pete, what your dry powder situation looks like?

Peter Briger

I would say that we have in our credit hedge fund a couple of billion dollars of capacity on the debt side from facilities that we've put in place that are term facilities. Then in the various funds on the credit and asset side, we probably have another $1.5 billion of equity capital.

Wesley Edens

The market is distributed between debt capacity and the different funds, equity capacity and the different funds, split out both by hedge funds, as well as private equity. And we don't detail the breakout by fund, but it is distributed among each of those three sectors.

Marc Irizarry – Goldman Sachs

Can you just discuss redemption requests in the first quarter, and how that breaks out by fund?

Peter Briger

The only fund group that really has redemption available is the liquid funds. We had approximately $420 million in the macro fund, $140 million in the commodities fund, so roughly 12% to 13% of the assets under management.

Operator

Your next question comes from the line of Craig Siegenthaler with Credit Suisse.

Unidentified Analyst

I am filling in for Craig today. I just had a quick question. Could you could put a number on the debt coming due in '09 and 2010?

Daniel Bass

At the Fortress level, it is $75 million in '09 and $100 million in 2010.

Unidentified Analyst

Is this the number that is comparable to the $5.4 billion?

Daniel Bass

No, the $5.4 billion was the number in the private equity funds.

Unidentified Analyst

So what would be that comparable number?

Wesley Edens

We did not break it out for this. At our last conference call, I actually put together a slide presentation and broke out the financing that was due across each one of the businesses both for last year and this year, and I did not do that same comparison for this year. It has not changed too much from that, so if you go back and reference that, that gives you a very good indication of it.

Unidentified Analyst

If you could just talk about deleveraging and what you conceptualize for leverage levels for the business going forward?

Wesley Edens

Deleveraging in the business being the core business at Fortress?

Unidentified Analyst

Yes.

Wesley Edens

Well, we are obviously in an environment with all the volatility in the world that you would love to have no leverage. At the time we put the leverage on the business, it was about one times cash flow, and still even today, it is actually very modest leverage relative to EBITDA multiples and the like, but eventually the quest really is a combination of liquidity from balance sheet liquidations, as well as just from cash flows from our business, our goal is to reduce our leverage down even more than we have and eventually get to zero. We’ve made we think very constructive changes to the debt so that it gives us lots and lots of room on things that are not in our control and take it as asset tests that I talked about and Dan talked about, but no question that our goal over the medium term is to get into a position of where we are deleveraged completely.

Operator

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

Robert Lee – KBW

I have a question going back to capital formation. Should we be thinking given the opportunities you see out there that on new capital formation for this year that pretty much what you have in-house, the $1.5 billion, the additional leverage capacity or debt capacity in the hybrid fund is pretty much going to be it for awhile? Do you see any opportunities to raise additional capital for the coming quarters to take advantage of some of this?

Wesley Edens

For us we think that there will be substantial debt and asset opportunities that are going to come forward in what we're calling the great liquidation, and so we will certainly be out raising new credit and asset funds and trying to take advantage of essentially lots and lots of government and financial institution liquidations that are going to take place over the next three or four years, so it’s quite possible that we raise new funds for credit and assets this year.

Robert Lee – KBW

Can you maybe give us some color on what your LPs are saying maybe about you guys specifically or in general given all the stresses out there that have been well-publicized, that a lot of LPs are suffering through, where you think their head is at in terms of being willing to commit capital at this point or even having it I guess, and then maybe to what extent does the pressure that has been exerted on your stock price and being in the public headlines glare, has that been kind of the negative you have had to work through with a lot of LPs?

Daniel Bass

It is certainly something that our LPs are focused on. Obviously when we are asking them to make long-term commitments to Fortress, they want to know that we're going to be here for the long-term, which is really why we entered into this bank debt amendment that we did. As Wes mentioned, there is really no covenant issue that is concerning two us, but really more an issue for the long-term of figuring out how we would position ourselves to raise more capital. I think the unintended consequences of things happening in the marketplace lead us to want to be in a position where you would have to have significant draconian events taking place that are either Fortress specific or in the markets that we traffic to be negative.

Wesley Edens

With respect to the LPs themselves, of course, everybody has had great amounts of pain suffered by the market declines, starting with the stock market, but then spilling over to alternative investments across the board over the last year and a half. I think within that people do understand that times of great pain are also times of great opportunities. Pete's credit fund, the $3 billion fund, was really raised during the fourth quarter, which was without question the most difficult period of the financial markets since we have been doing this, and I'm optimistic that we will actually find lots of incremental capital.

For as much difficulty as there is in the market, there still is an abundance of capital that sits on the sidelines, perhaps more so now than frankly there ever has been, and what really has been lacking is a degree of confidence that the reforms that the government is pushing through, the stability in the financial system are going to translate into real stability in the underlying economy. I think once you get that perception into the marketplace, I think you can see significant amounts of capital come back to work, and we believe that we are going to get our share of it.

Operator

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

Roger Smith – Fox-Pitt Kelton

I just want to go through a couple of roll-forward questions and make sure that I fully understand things, and I guess with the liquid hedge funds, they have $7.2 billion of end of period AUMs, and I think in the press release it talked about $2.4 billion of those being redemption type of assets, and then you had talked about the $3.3 billion coming out. I just want to make sure how do I roll all of that stuff through?

Daniel Bass

The $3.3 includes the $2.4, and $900 million, which is the difference, is in an SPV that will be liquidated over the course of the next 18 months.

Roger Smith – Fox-Pitt Kelton

Is that a non fee paying AUM during that liquidation period?

Daniel Bass

No, it just has reduced fees, but it is in AUM.

Roger Smith – Fox-Pitt Kelton

Then the same thing on the hybrid where we ended with $6.5 billion, and there's $1.5 billion of notices? That one I'm assuming as those assets either mature or come back is when the fees actually stop paying during this period. Is it the same fee structure that we have, and then what would be like the expectations could we think about? I know when you put up this slide last quarter, it talked about a duration of three and a half years. Is that something we should be thinking about as these redemptions come through that they would stagger over that type of period, or would this be a one-year type of thing?

Daniel Bass

With respect to the redemptions that were effective as of January 1 of this year, those will be paid out as they are realized in a private equity style format, and to the extent that there are future redemptions which occur annually, the decision as to whether or not those will be paid out in a private equity style format or more quickly as per the documentation will be made at that time.

Roger Smith – Fox-Pitt Kelton

That I assume is fair, but I guess for us for thinking about a modeling point of view, would you suggest us then to look at that 3.4 or so years of duration as something we should use as a milestone or marker?

Daniel Bass

I think that in these markets it is very difficult to estimate how those cash flows will come in, and I think that in terms of our communication with our LP investors, obviously our interest is in making sure that those are conservative predictions because people have to manage their cash on the other side. I think that some kind of three-year average life with respect to the payout of those cash flows is reasonable at this time period. But it is a very imprecise calculation.

Roger Smith – Fox-Pitt Kelton

No doubt. Last quarter when we had this conference call, there were talks that redemption levels would likely tick up in 2009, and what’s more of your general feeling on that view now? Is it changing at all?

Wesley Edens

My sense is that the bulk of the redemptions happened in the fourth quarter, and the panic amongst the liquidity needs were most severe because of the uncertainty in the fourth quarter. People still have cash needs, and what we saw in our first-quarter redemptions was not people voting to get out of the fund in general, but everybody needing a small amount of capital, and so I think in all of our redemptions there was only one complete redemption. Everyone else they were partial redemptions. My sense is the total level of hedge fund redemptions will bottom out sometime this year, but already the pace is slowing down a dramatic amount.

Roger Smith – Fox-Pitt Kelton

On the leverage, on the margin debt at the fund level and the PE, you said you had a couple of hundred million dollars there last quarter. My expectation was that you were looking to potentially pay that off. Has that changed, or do we have still some debt there, and then on the hybrid fund, when you did talk about capacity there, are we still thinking about a one-to-one type of leverage expectation?

Peter Briger

On the margin debt on the PE fund, I think actually this week we expect the last of that to be extinguished. It is just a matter of actually processing the transaction that is already capital formed and paid for and what not, so just literally in the next day or two we expect that to go away. That will be the end of any margin debt in the private equity business. That is good news, but that has been something that has really occurred a number of months ago and is just in the process of happening.

What was the second part of the question?

Roger Smith – Fox-Pitt Kelton

On the hybrid, you just talked about some capital formation, and the one-to-one was what I thought in the past.

Peter Briger

The one-to-one debt-to-equity ratio that we talked about is a function of actual debt outstanding, so as we draw the debt facilities down, the equity associated with those facilities is already in the fund, so leverage would go up slightly. I would imagine that if we are able to use all of the debt out there that the leverage would go up potentially to 1.5 or 1.75 to 1. I don't anticipate us using all of that debt at any one time, and there is a certain amount of roll-off from those facilities that occurs.

Roger Smith – Fox-Pitt Kelton

You had listed in the Q last quarter that $3.9 billion of your invested capital was now marked below the invested capital level was originally. I think we have $11.3 billion of invested capital. Could you tell us what that number is, and are there any investments that you have in there that are marked down to something like down to zero or significantly marked down?

Mike Novogratz

I don't exactly have the $3.6 billion number as of year-end that you mentioned, but there are quite a few that are below cost at this point in time. Nothing is down to the zero level as you have mentioned.

Roger Smith – Fox-Pitt Kelton

The last thing I will ask you is really on this TALF. I just want to make sure that I understand because in my mind I think there's really two ways you could play it really as an investor and as a borrower, and I think most of the discussions more were really as a borrower or a financier. Is this something that you as investors would think about participating in as well and raising capital?

Wesley Edens

Yes, absolutely. I think the way to think about it is that TALF as it is currently configured is designed to help issuers of credit cards, auto loans, and student loans issue debt. That debt will then have investors who will put up some incremental amount of haircut capital and then be taken by a dealer to the Feds so they can borrow against that in a three-year noncallable, non-mark-to-market facility. As a result, there's two interested parties. On the one hand, you have got the credit card issuer as an example that now is issuing debt at maybe 175 basis points over LIBOR, whereas prior to this they could not issue at those spreads if they could issue at all just given the shutdown in the capital markets. On the flip side, you have got then investors that would put up the haircut capital and would earn returns of mid-teens to maybe low 20s in return for putting that capital up for that period. That is how TALF is currently configured. My understanding is that there is actually a fair bit of interest on both sides, both as issuers as well as from the investment standpoint, and now what remains to be seen is just how the water flows through the pipes and those things actually come to pass. The first funding, as I said, is scheduled for this Thursday, and although it is relatively simple to conceptualize, just making any one of these things happen is a challenge in an expedient and transparent way.

I think that in addition to that the next level of things that are being contemplated are looking at legacy or existing assets and having the Fed provide through TALF financing for those assets as well. Haircuts undoubtedly will be higher in that you're looking at legacy assets that have different histories behind them, but the impact in the marketplace I think from an asset perspective could be profound. Again, this does not exist, so it is easy to talk about how it might work prospectively, but as an investor if you could go out and buy in legacy assets some that are trading at mid-teens to even low 20s in certain cases unleveraged returns and be able to finance yourself on some constructive basis, the prices of those assets might actually return to something that more approximates fundamental value than the liquidity premiums that they attach to right now. That would be good for the marketplace. It would be good for the balance sheets of the financial institutions that are large holders of these assets. It would be a good thing overall. I do know we have had lots of conversations with the government at various levels about this. We think that they are working hard and constructively on that, and the devil is in the details, but we're hopeful that something will come to pass sooner rather than later.

Operator

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

Roger Freeman – Barclays Capital

With respect to the first-quarter redemptions, so the 12% to 13% you were talking about on the liquids, that is the number, right? You've got a good view of the quarter at this point?

Peter Briger

Right. The most they can be at this point is 425 for the Macro Fund and 135 approximately, and we might miscalculate them some based on the performance this ensuing month. People could actually withdraw redemption requests, so right now because people are managing their own liquidity in a fairly choppy environment, some guys will put in for more than they need. Up until the last day, we would know if they are going to keep the redemption request in or withdraw it.

Roger Freeman – Barclays Capital

Is it fair to say that that is pretty much actually a gross number, that there were more no meaningful inflows?

Peter Briger

Yes. We did not raise any capital this month.

Roger Freeman – Barclays Capital

The performance numbers are pretty decent. I think the hedge fund industry as a whole has done much better year-to-date. Most hedge funds are up. How much of the improved performance would you say is due to the restructuring inside of the liquids, particularly the macro versus just overall improved market conditions, better asset correlation or more historic correlation, etc.?

Peter Briger

It is a hard question. What I would tell you is that we did a pretty dramatic restructuring. We went from 25 portfolio managers down to three or four, and that has simplified our business. It has simplified the operation of our business greatly. I think we have put a great foundation in for future returns. The markets are well set up for macro investing and macro traders. When we talk to investors, most of them have the approach they are going to take a barbell approach to investing that they want to be in liquid macro trading strategies or lock their money up much longer in distressed credit opportunities. So in some way, Fortress is well positioned on a go forward basis. For our part we're going to try to make the macro fund has transparent and as liquid as possible.

Roger Freeman – Barclays Capital

The 25 down to three or four PMs, was most of that done during the fourth quarter, because I think you had been restructuring it all year long, including getting rid of the sector guys earlier in the year?

Peter Briger

The bulk of it happened in the last two months of the year.

Roger Freeman – Barclays Capital

In terms of the sustainability or the future growth ambitions for macro, are there any scale levels that you actually need to get back to to say we're in this business for the long-term, or if you're running at these kind of levels, are you fine with that?

Mike Novogratz

The great part about our business is that the cost structure is all in the people. So we feel pretty comfortable running at this level. I do think that with a few more months of positive performance and we have been in talks of lots of investors that you will start to see inflows into the funds.

Daniel Bass

Wes, just two for you quickly and I will hope off here. In terms of the private equity opportunities, you have been talking about banks as an area of interest for awhile and insurance companies for a year or so, but you have not done anything yet. It sounds like you have a few things in the hopper. What are the holdups? Is it more of the structuring of how you do this inside of private equity, or is it just waiting for the valuations to get to the right level?

Wesley Edens

In private equity in particular it has been difficult to see your way clear to making new investments while there has been so much volatility in just the liquid markets. You have the stock market down 25% in the course of a couple of months. You have all the disruptions on the credit side. I think that for the most part private equity investing is going to look quite a bit different for the foreseeable future in that there is going to be a lot more focus on investing through the debt and investing through distressed opportunities, which is something we have done a lot of in our life. Then there will be kind of the classic buyout stuff that was perhaps done over the last five or 10 years.

The financial institutions, the pace at which the government has resolved the financial institutions has been modest when you consider the dimensions of what it is they are trying to get their arms around. I think when you look at the bill that was introduced by Senator Dodd 10 days ago to increase the FDIC funding by $500 billion. When you look through at all of the stress testing that is going on with some of the bigger banks by the Fed and the treasury as we speak, it certainly seems to us and it seems to me that the opportunity set with respect to the banking sector is just about ready to start, and we have spent a lot of time on the structural side. There is lots of complexity in terms of just thinking through how to go out and attack it. We've got a couple of very specific initiatives that we're working hard on now, and it could be something that has a real big impact on our lives. We think that when you look back at the experiences of the RTC, some of the great fortunes were really made by people that invested directly in the banks themselves in addition to just the assets, and so there is regulation that comes with that, and there's a lot of things to consider, but it is something that is really, really worth a hard look and something that we think we're pretty well set up to do.

Roger Freeman – Barclays Capital

Do you think it is something we could potentially see here in the second quarter or maybe a little bit beyond that?

Wesley Edens

I hope it is something you see in the near-term. I cannot predict anything these days because it is all such a challenging environment, but I think it is something which is actionable near-term, not just six months or 12 months from now.

Roger Freeman – Barclays Capital

Lastly on regulation, can you just comment on how you expect things to evolve? It looks like Europe is looking for tougher regulations, maybe the US a little lighter, but particularly around the large hedge funds. At this point what do you expect?

Wesley Edens

I don't know if you saw the 60 Minutes piece with Chairman Bernanke last night, but I thought he talked about regulation in a pretty sober and clear-sighted way, which is we have got ourselves into a position where there was just too much systemic risk in the system, and the downfall of one or more than one of these large institutions could have huge knock-on effects, and it is pretty clear that a real focus of the government and probably appropriately so at a basic level is to increase the oversight and regulation so that those kinds of things can't happen in the future. First you need to fix what needs to be fixed, and you need to provide capital flows and stability in the financial system, and then I think you have to take a hard look at how you got from there to here, and things like the credit derivatives market and things like financing counterparties and things like capital adequacy. I think all those things will be on the table when they come back, and clearly there is going to be more regulation in front of us.

We are SOX compliant. We have enormous amounts of real infrastructure here. We have been an SEC reporter for a long time. We are a public company, so I feel like on balance we're much better prepared for a more regulated environment than many of our brethren. We're not worried about it in our day to day business, but it clearly is coming, and at some level, like I said, it is probably quite appropriate.

Operator

Ladies and gentlemen, we have reached the allotted time for questions today. I will turn the call back to management for any closing remarks.

Lilly Donahue

Thanks, everyone, for joining us today. If you have any follow-up questions, please don't hesitate to give me a call.

Operator

Ladies and gentlemen, that concludes the Fortress fourth-quarter and year-end earnings conference call. We appreciate your time. You may now disconnect.

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!