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

SWS Group, Inc (NYSE:SWS)

F3Q09 (Qtr End 3/27/09) Earnings Call

May 06, 2009 10:00 AM ET

Executives

Meg Gupton - Corporate Communications

Donald W. Hultgren - President and Chief Executive Officer

Kenneth R. Hanks - Executive Vice President, Chief Financial Officer and Treasurer

John L. Holt Jr. - Executive Vice President SWS Group, Inc.; Chairman, President and Chief Executive Officer Southwest Securities, FSB

James Harrell Ross - Executive Vice President SWS Group, Inc.; President and Chief Executive Officer Southwest Securities, Inc.

Analysts

Hugh Miller - Sidoti & Co, LLC

Joel Jeffrey - Keefe, Bruyette & Woods

Edward Hemmelgarn - Shaker Investments

Meg Gupton

Good morning and welcome to the SWS Group Quarterly Conference Call and Webcast. This is Meg Gupton, of the SWS Corporate Communications staff. We are pleased you could join us today.

Our quarterly earnings press release can be found on our website at swsgroupinc.com or on the Yahoo! Finance website under SWS News. Market professionals on our distribution list should also have received the files for today's call via e-mail. As you are invited to add into our e-mail list to receive press releases or to be noted by the future quarterly calls please contact us at 214-859-6351.

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

This presentation contains forward-looking statements. You are cautioned that any forward-looking statement, including those predicting or forecasting future events or results which depend on future events for their accuracy, and by these projections or assumptions, words express the intent, belief, or current expectations of the company or management, are not guarantees of future performance and involve risks and uncertainties.

Actual results may differ materially as a result of various factors, some of which are out of our control, including, but not limited to volume of trading and securities, volatility of securities, prices and interest rates, availability of lines of credit, customer margins, loan activity, creditworthiness of our correspondents and customers, demand for housing and other factors described in our annual report on Form 10-K and in our other reports filed with and available with the Securities and Exchange Commission.

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

Donald W. Hultgren

Thank you, Meg and thank you all very much for joining us this morning for a discussion of our third quarter results. I'd like to introduce the participants on the call. Joining me today are Ken Hanks, who is the Chief Financial Officer of SWS Group; John Holt, who is the President and Chief Executive Officer of Southwest Securities FSB, our bank, and Jim Ross who is President and Chief Executive Officer of Southwest Securities and SWS Financial, our brokerage firm.

Let me first go over the agenda. I will provide an overview of our third quarter and review some noteworthy items and touch on some important events since our last conference call. Ken Hanks will provide a more detailed review of the third quarter. John Holt will provide an update on activities at the bank. And I will discuss our market position as well as our three preprimary growth initiatives. Finally, we'll open it up for questions and we get into the queue. If you are on the phone its star one; if you are on line its questions at swst.com.

Let me start with a third quarter overview. As you know we pre-announced the results for this quarter and the results came in at the high end of that preannouncement. Revenues in the quarter however decreased from $120 million than last year's third quarter to $114 million this quarter.

Net income decreased from $8.6 million than last year's third quarter to $4 million in this year's third quarter. Earnings per share in the third quarter decreased from $0.32 last year to $0.15 this year. And finally, we ended the quarter with a book value of $12.27 per share.

Now let me turn to some noteworthy items in the quarter. The third quarter was a short quarter in terms of the number of trading days in it. The quarter included 59 trading days compared to 66 trading days in the December quarter. Last year's third quarter contained 60 trading days.

During the quarter, we continued to enjoy strong activity in our taxable fixed income department. Revenues in taxable fixed income were up 205% compared to last year's third quarter, while pre-tax income increased 523%. The quarter was negatively impacted by charge-offs in our commercial real estate portfolio at the bank.

One property accounted for $2.1 million of the total charge-off. On an encouraging note, we experienced a 40 basis point improvement over the December 2008 quarter on a net interest margin at the bank increasing it to 4.79%. We have more pricing flexibility at the bank even as interest paid on deposits decline.

Important events since we last talked. We are seeing in my opinion what may be a once in a lifetime opportunity to attract professionals to our firm. The turmoil in the financial markets has caused many producers to reassess their situations at their adjusting firms. We are seeing extremely talented individuals for our institutional and retail brokerage operations as well as our bank.

During the quarter, we transferred $50 million in capital to the bank from the broker, dealer. The purpose of this capital infusion was to support the growth at the bank especially that which is being generated by the recent additions to our team of bank.

Recruiting of retail financial associates has also been very strong. Our Private Client Group increased by six professionals in the quarter. In addition, another eight have been hired since the quarter ended. As I mentioned, the opportunity for us to grow right now is unusually good.

Finally, we want to welcome new research coverage from Fox-Pitt, Kelton. We are excited about how we are taking advantage of these growth opportunities and we appreciate the help of getting this message out to the investment community.

Now with that, let me turn it over to Ken to go into more detail on the quarter. Ken?

Kenneth R. Hanks

Thanks Don. Good morning everybody. Well, before I get started on my comments on the quarter I want to make a kind of early warning administrative notice to all of you model builders out there that have included a line for M.L. Stern as a separate part of our financials. Once we file our K this year, we will no longer disclose any information on M.L. Stern individually within our filed report.

So if you are building your models with that in there, you just need to take that into account if they are part and parcel of the Private Client Group and beginning with our first quarter of next year, they are just going to be within Private Client and not shown... not to have disclosed the separate numbers. So with that I'll go ahead and also a little bit more color on to Don's comments on fixed income.

As we began the quarter many of you were curious as to whether the taxable fixed income markets would remain as strong as they were in the September quarter. And today we can report that not only were they as strong, but were actually better in terms of our revenues and profits.

Additionally the favorable results were spread among virtually all of our taxable lines of business. Corporate lines, agencies and mortgage backed securities. At the same time, fixed income as doing this great business may also selectively hiring producers in our areas of expertise to broaden and deepen our capability.

With that said, I would like to spend a few comments discussing a quarterly summary of financial results, then move on to a more detailed discussion of our operating results and conclude by discussing our segment results.

First on the income statement. Net revenues for the quarter, that is operating revenues plus interest revenues, less interest expense were up by $20.6 million or 28% for the quarter, while pre-tax earnings were down $7.1 million or 51%. The M.L. Stern division of Southwest Securities contributed net revenue of $11.2 million and expenses of $12.1 million or a pre-tax loss of 900,000 for the quarter. There were no amounts for the M. L. Stern division last year as the acquisition did not close until April 1st.

Turning to a review of our individual operating revenue line items. Net revenues from clearing were down 32% for the quarter. In the quarter, we processed 728,000 trades down from 9 million in the same quarter a year ago.

Day trading tickets were the primary driver of the decline in tickets as the full impact of the loss of one correspondent was reflected in the third quarter numbers and additional correspondent transferred substantially all of their day trading business to other culinary.

On the other hand revenue per were up in the March 2009 quarter and was $3.30 versus $0.40 per ticket in the same quarter last year. This change is primarily attributed to the reduced volume from day traders in the current quarter of last year.

Commissions were up $19.1 million or 70% in the quarter with $8.2 million of the increase coming from M.L. Stern, while all retail operations showed a decline of 1.6. As previously mentioned the taxable fixed income businesses had extraordinary performance with commissions surging $15.4 million versus last year's quarter.

Investment banking and advisory fees were down 3% in the quarter, fees of 1.3 million primarily from the asset management business at M.L. Stern were offset by reduced fees from public finance transactions, as the new issue municipal market has been very sluggish.

Net gains on principle transactions, which will go out principally from trading and fixed income securities were up $9.4 million in the third quarter as compared to the third quarter last year. Taxable trading contributes $6.9 million of the increase; our municipal trading was up $1 million, M.L. Stern was the last major component of the increase.

Other revenue is down $2.9 million for the quarter, primarily due to reduced sales of insurance products. Additionally, last year's third quarter included a gain of $656,000 related to the bank sale or the factoring position.

Net interest revenue which is interest revenue less interest expense of $23.8 million was down 13% from last year's quarter. The bank's net interest was up 37% while net interest at the brokerage was down 54%. The decrease in brokerage net interest was driven by reduced spread on customer funds on deposits as the rates we earned over reserve account asset has dropped to near zero.

Additionally, net interest earnings from securities lending was down due to a 42 basis point decline in the unusually high average spread in this business last year. However, rates for the quarter were still approximately 25 basis points better than historical norm. Falling with a 40% drop in average balances when compared to last year's quarter, balances were actually up 6% when compared to the December quarter.

Net interest of the bank was up 37% into a 23% increase in average loan balances and a 55 basis point improvement in the net interest margin. Average margin balances in the customer side of the brokerage business of $151 million are down 11 % from the previous quarter and down 44% from the same quarter of last year due to market activity.

Credit balances were down 15% from December and 33% from March last year. As mentioned earlier, stock loan balances are up 6% from December. Stock loan balances have seen a significant decline since last year, as activity in the markets related to this business continues to be depressed.

The balance declines have come from reduced willingness of institutional holders to longer securities and reduced volumes in the market. Average gross loans at the bank were up 12% over the December quarter and up 26% over the prior year. The current environment has produced opportunities to selectively lend on better terms than previous years.

Turning to operating expenses. Operating expenses where up $28 million from the prior year's quarter. M.L. Stern accounts for $12.1 million of the increase. Compensation expenses -- compensation expense was up $17.1 million was $8.6 million related to Stern and the remainder related to increased commission expense in the fixed income area.

Occupancy and equipment expenses were up $2.1 million from Stern expenses as well as cost of new branches of the bank. Communication expenses were up $873,000 from Stern as well as additional expenses in the taxable fixed income area. Floor brokerage expense was up $1.5 million versus last year.

Last year, we received rebates from our clearing houses that totaled almost $1.7 million, while this year rebates were under $200,000, because clearing houses reduced their fees to eliminate the large one-time rebates for the spread of the year versus being down in one quarter now.

Promotional expenses were up to accommodate travel associated with the continued integration of Stern. Other expenses were up $5.9 million primarily due to the $5.1 million increase in the bank's loan loss provision as well as increases in the real estate expenses associated with REO property.

This slide presents operating results by segment for the third quarter. Our first segment is clearing. This business encompasses our share of all the fee revenue collected from our correspondents or their customers as well as the net interest earned in our correspondent and correspondent customer account.

For the third quarter this segment are $92,000 down from $3 million last year. Clearing fees were impacted by reduced fees from day trading clients as the previously announced departure of one client was completed as well as the transfer spend for all of the day trading accounts of the additional correspondent.

Compressed interest spread and reduced customer margin balances reduced net interest in this segment by $1.5 million and reductions in operating business have not been enough to offset these declines. If you take a look at the Clearing business for the nine month in this segment information, you would see that 100% of the change in the profitability of the segment relates to net interest income.

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

As we indicated previously M.L. Stern contributes $11.2 million of net interest revenue and had a $900,000 of loss in this segment. Excluding Stern, the Retail segment posted net revenues down 24%. February was one of the toughest revenue months we have experienced since we began to focus on the retail business in 2003.

Revenue declines were posted both in commission revenue and in interest revenue as spreads and balances remain depressed. Contribution from our independent contractor business was down approximately $785,000 from reduced revenue, while the Private Client Group contribution was down almost $2 million from reduced net interest revenue and increased expenses from new offices.

The new offices since last year are in Houston and Southlake, Texas, which is a forward suburb. The Institutional segment consists of our brokerage businesses that serviced institutional customers, including fixed income sales and trading, public and corporate finance, equity and portfolio trading, as well as stock loans.

Pretax for this segment was up 18% for the quarter as the fixed income trading businesses produced dramatic increases with pre-tax income up 523% offsetting with this contribution from stock loan in the public finances.

The volatility in the marketplace as well as increased spreads contributed to improvement to taxable fixed income. Stock loan results were down 62% from prior year as market conditions reduce balances and spreads. The equity side of the institutional business was up 37% as reduced volumes impacted revenue.

The Banking segment produce an increase in net revenue of 21% however, the $5.7 million addition to the provision for loan losses increased REO expenses as well as compensation from increased head count over the last year caused an 88% increase in operating expenses in the third quarter. John Holt, the CEO of the Bank will provide additional color on the banking environment a little later in the call.

The other segment includes corporate investments as well the unallocated corporate administration expenses. This has primarily record the results of our venture capital investments as well the administrative cost of accounting, legal and other corporate shared services. Primary changes contributing to the $2.4 million reduction of pre-tax loss, included reduce executive incentive compensation, reduced legal and other professional services business and reduced cost of our benefit program.

Lastly, I would like to discuss a few operating expenses for the quarter. Tickets processed decreased 92% from last year's quarter, while dropping 70% from December. Activity from day trading customers is the primary driver of these changes.

PCG rep that is Private Client Group rep are up significantly from last year and include a 103 reps from the M.L. Stern. We are also selectively hiring in the institutional area as other firms close down businesses that we believe, will be profitable for us. The total employee head count increase includes over 200 for Stern with the rest mainly in the banking area. Head count is down 20% since the December quarter and we did with this head count as the bank end in for individual.

Our next slide represents average loan to positive capital balances at the bank. The capital numbers reflect the additional $15 million in capital allocated to the bank during the quarter. We also highlight the amount of deposits provided to the bank by brokerage customers, which averaged $992 million in the third quarter versus $828 million last year.

Our reserve to loan ratio was up to 99 basis points, while our percentage of non-performing loan total assets goes up to 3.87% from 3.09% in December. Net charge-off of 3.5 million were up substantially versus the December quarter and last year's March quarter. We expect this number to continue to be elevated levels for a few more quarters.

As a reminder, as non-performing loans move to foreclosure status, we require updated appraisals and estimates of selling costs on the property. This determines the charge-off amount that reduces our loan loss.

Allowance, at the end of the period we update our loan loss allowance computation in terms of amount need to save the reserve at an appropriate level based on our loan portfolio. This is what generates the loan loss provision that is income statement. In the March 2009 quarter the provision for loan loss allowance was $5.7 million. Our net yield on earning assets increased 40 basis points in December, and was up 55 basis points this March of last year.

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

John L. Holt Jr.

Thanks Ken. I would like to update our listeners on the bank's results overall as well as provide an update on the growth and our commercial banking group. The banking segment reported a pre-tax loss for the quarter of $339,000, and this is primarily related to increased provisioning and the credit related expenses, that was offset by improved average net margin of 4.8%.

The banks provision for loan losses did increased to $5.7 million from $1.8 million over last quarter, while net charge-offs were $3.5 million. As a result, we had a $2.2 million to the allowance, which brings reserve to $11.1 million or 99 basis points of loans. Of note, over $2.1 million of the charge-off during the quarter was related to an owner occupied commercial real estate firm to the local automobile dealership. The bank only has fixed additional automobile industry relationships, totaling approximately $9 million.

Non-performing assets increased during the quarter to $57.7 million, up $13.5 million from the December quarter and represent 3.9% for the last year. The growth in non-performing assets was concentrated primarily in three commercial real estate related threats, as these loans generally have a tendency to be larger in size.

Total non-performing assets at quarter-end primarily consisted of $23 million in commercial real estate, $16 million in loss in land development, and $50 million in residential construction. We are actively managing our portfolio of special asset and had experienced favorable sales volumes in our residential construction related asset with over $5.3 million of property dealer sold or under contract at the quarter-end.

On February 27, 2009 FDIC adopted an interim rule imposing a f 20 basis points emergency special assessment on the industry's insured institution deposits as of June 30, 2009, which will be collected on September 30, 2009. The FDIC has subsequently stated it could reduce the special assessment to as low as 10 basis points if U.S. Congress enacts legislation that would increase the FDIC's borrowing authority from the U.S. Treasury from $30.0 billion to $100 billion. The interim rule also provides for future special assessments, if needed and we are continue to monitor these developments for a special assessment and the end (ph) aren't sufficient.

During the quarter, we opened a full-service commercial banking center in Houston, Texas which brings us the full-team, full-service commercial centers Texas and New Mexico.

Additionally, we have been successful in recruiting talented bankers as many locals who are at regional banks retreat in the marketplace. I would like to note that during the past few years the bank has opened six new full-service commercial banking facilities. The new facilities generally result in a short-term charged earnings, however we are committed to the long-term earnings for each commercial banking centers will add. As such we will continue focus our efforts on growing our commercial banking franchise of moving banks around experienced bankers across Texas and the Southwest.

Our mortgage purchase department continues to provide strong earnings for the bank as funding increased over $2.25 billion with over 11,500 files processed (ph). Outstandings for the quarter averaged $297 million up $321 million the prior quarter. This portfolio has been turning very quickly as indicated by number of files, and better volumes funded.

We continue to primarily fund pre-sale loans that consist of government Fannie, Freddie AIG and other conforming mortgage products. There continues to be a lack of competition in the marketplace for this product and large institutions that exited this market.

The bank is well positioned to take advantage of the unrest in the marketplace as our stable and low cost earning source provides a profitable platform to leverage our teams of talented bankers. We are accurately managing of our portfolio of special assets and continue to manage more spread, I am confident that our business model of recruiting teams of experienced bankers and we look forward to updating you on our progress in the coming quarters.

Thank you very much for your time. And with this, I'll turn it back over to Don.

Donald W. Hultgren

Thank you, John, Once again those of you who might want to get in the queue for questions, if you are on the telephone, its star one to get in the queue. If you are online you can submit a question by e-mailing questions at swst.com. Let me refresh you on our current market position. As you know, we spent a number of years refining and focusing our business and to what we believe a market that not only are large, are also very defensible.

Today, we're the largest brokerage firm that's headquartered in the Southwest part of the country. We are the fourth largest bank headquartered in Dallas. And we're one of the largest clearing firms in the United States based on a number of clients that we have.

Let me take a moment to review with you our strategy for the bank and for the Private Client Group. The key idea here is that we are building a franchise in the Southwest part of the country. As you know, we have been expanding our broker base in Private Client Group both through acquisition, and now as I mentioned earlier through very healthy recruiting.

As we bring in those brokers and they bring in their customers, we continue to see the cash balances that we have at the brokerage firm expand with those additions. We will sweep much of those cash balances over to the bank, and today over $1 billion in deposits at the bank are there being swept from the brokerage side of the business.

Unlike some other broker banks, we originate substantially all of the loans that we have on the brokerage.... or on the bank side of the business. As a result we have close to $1.5 billion in loans outstanding to businesses that where we have relationships with the people who run those businesses.

The bottom-line is that we have relationships with our brokerage customers, we have relationships with our banking customers and we continue to grow both the brokerage and the bank. And it's our opinion that that relationship driven financial institution that we're building in the Southwest part of the country will indeed be a franchise that grows in value over the coming years.

Let me turn to our corporate direction, which dug tales on when I was just staying with the map. We have really three agendas which is to grow our clearing business and add more customers, grow our broker, dealer and grow the bank.

Let me first start with growing the broker, dealer. I can't stress enough to you what a special environment we are in today in terms of how many brokers we are seeing that are interested in new opportunities with new firm. We I believe offer a great alternative for those financial professionals, they are our customers. We provide them with a platform to serve their customers in a fashion that they think is the most beneficial for those customers.

But its not just retail; as Ken mentioned we have been aggressively growing our institutional ranks of bankers, sales people and traders which we've seen paid off now of course with our fixed income business. But we also need to grow the bank. The situation at the bank is very similar to the situation at the brokerage front. There are a multitude of talented bankers, who are in the process of deciding where it is they're going to be practicing their trade in the years ahead.

We again think we offer an outstanding opportunity for those bankers to join our ranks and take advantage of the deposit growth that we have from the brokerage firm. So we've added many talented bankers who are in a process today of growing their loan portfolios. And as I mentioned, we transferred $15 million from the broker, dealer to the bank to support that growth in those loan portfolios. We have ample deposits and we have added this additional capital to help to facilitate the growth.

Finally let me turn to the growth that we are looking for in our clearing business. Many of you know that we have excess capacity in our clearing business, and as a result of that we have the opportunity to unlock substantial operating leverage as we add additional customers to the clearing business. And many of you know we invested heavily in new professionals, new management, new sales force, and new product professionals.

Our sales force today has now been with us for just over a year, the three primary sales people. The clearing business has a long sales cycle. And I would tell you today that I am encouraged by what I am seeing in terms of the activity that's been generated by the sales force. And so we look forward to seeing growth in the clearing side and obviously unlocking the operating leverage that is there.

Finally, let me turn to opportunities. I think I said this quite a few times and I'll say it again. This is the time of great opportunity for SWS Group. In recent years, we have succeeded in focusing the firm on those business areas where we have the ability to capture market share. We have brought in professionals with fresh ideas and energy to help us grow the bank and broker, dealer in our clearing business. And our balance sheet remains strong.

We are well positioned at a time when many in our industry are struggling. Again to be redundant there are many talented professionals available to join our team. I believe as time influence on conditions means that in the quarters ahead, we should be able to dramatically expand our core businesses. Hopefully the credit markets will loosen and provide greater access to capital, so that we can take full advantage of these opportunities.

I look forward in the months ahead to able to talk with you about capitalizing on these great opportunities. In closing, these are exciting times for SWS Group. We're a financially strong firm facing unusually good opportunities in the top market. I want to thank our employees and though above and beyond the call of duty everyday. SWS Group has great employees that I'm proud to be on their team. Also want to thank you our customers, they are reasonably are here and we strive to earn new business everyday. And finally thank you to the shareholders for your confidence and support and I look forward to sharing our progress with you in upcoming quarters.

With that, let's turn it over to questions. Again star one if you want to get in the queue on the phone or questions at swst.com.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is coming from Hugh Miller.

Donald Hultgren

Hey Hugh, how are you this morning?

Hugh Miller - Sidoti & Co, LLC

Morning, good yourself?

Donald Hultgren

Thank you.

Hugh Miller - Sidoti & Co, LLC

First question I guess, just wanted to talk about the tax rate on a go forward basis. Obviously it's been a little elevated here for the past two quarters I think. But I wanted to get a sense there on what you expect on a go forward basis?

Kenneth Hanks

Hugh we'll expect a 38 to 39% range go forward.

Hugh Miller - Sidoti & Co, LLC

Okay. And then I guess looking at the bank, I was wondering obviously you mentioned that the three commercial real estate credits that they comprise some of the increase in the NPAs, but any how looking in the Q what the increase in the commercial real estate and a lot in land. I was wondering if you could just may be provide a little bit of color on the quarter on that increase and may be what the typical loan to values are for those types of credits?

John Holt, Jr.

This is John. The promotional side is going to be the car dealership that I did mentioned in the call that is an owner occupied dealership in Arlington Texas which is between Dallas, Fort Worth. And so ultimately that's the biggest part of it and then we have two other pieces of land that come in there and the loan to values are typically on land bill is worse than the 75% of loan to value range. However, appraisals today are all over the board as it relates to transit those values in the current market environment.

Hugh Miller - Sidoti & Co, LLC

Okay. And I guess again and looking at the reserve level of the bank roughly a 1% and comparing it to other bank's operating taxes at a probably closer towards the 1.5% level and given some of the challenges in the commercial real estate market. Should we anticipate that the reserve levels will continue to increase on a go forward basis?

John Holt, Jr.

Hugh, this is John, and the answer to that would be yes, over the next few quarter if you would probably experience that they increase in there.

Hugh Miller - Sidoti & Co, LLC

And any color as to what the target might be?

John Holt, Jr.

It just depends on the performance of the portfolio. We've increased it $2.2 million approximately this quarter, if we're hoping that there is a high level of market were coming up against we've got residential led us into this year. I think residential will lead us out. And even on the link quarters NPAs on residential actually they've gone down.

Kenneth Hanks

So, I think that, this is Ken, Hugh; we previously have discussed that we thought for the next couple of quarters we would... I think we are not targeted, but we feel based on our methodology, that its going to end up providing the provision of around $4 million each quarter, which is going to be less than what it was in this quarter, but still more than what we've seen historically.

Hugh Miller - Sidoti & Co, LLC

Okay. So 4 million is not just for the next quarter but it's to your thoughts right now at this point?

Kenneth Hanks

At least for few more quarters.

Hugh Miller - Sidoti & Co, LLC

Okay. And I guess looking at the retail brokerage business, you guys have commented how difficult thinks were in February, I was wondering if you could talk about activity levels that you guys were seeing in April and I guess so far very early in May versus the March quarter and whether or not are you seeing any encouraging signs there?

Donald Hultgren

Well I would say that it's certainly not as bad as it was in February, but the marketplace still seems to be volatile enough that the retail investor is not to the point of being 100% confident. So it's certainly not at the bottom but there is room for improvement, yeah.

Hugh Miller - Sidoti & Co, LLC

Okay. And you guys reported the increase in advisors both in the internal and the independent channels on a net basis. I was wondering if you had the figures on a gross basis for the recruitment efforts there in the quarter?

Donald Hultgren

We don't have that on our figures tips Hugh. We'll get back to you with that.

Hugh Miller - Sidoti & Co, LLC

Okay.

Kenneth Hanks

I'm not so sure that's not a growth gross that you guys have report...

Donald Hultgren

Well that's that net.

Kenneth Hanks

That was there on the slide. I think the eight since the end of the quarter so the eight that we did in April was a gross number Hugh. And this is a firm memory okay. I think from memory between December and current, the end of April we had gross at a 25.

Donald Hultgren

Yeah Hugh I guess from just a qualitative perspective on PCG recruiting, are coupled as over.

Hugh Miller - Sidoti & Co, LLC

Yeah. And I guess who do you guys then find yourself really competing against, when you're going through recruitment process who you're finding yourself coming up against?

James Ross

Yeah, this is Jim Ross. Everybody. I know that's a bad answer but everybody. We're getting people from major firms some of the regional firms. There is a competition. The competition right now is still everybody. I mean the other firms we're talking to one guy, who's coming from brand X and he's being recruited by Y, Z et cetera, we're talking to a guy at firm Z who's being recruited by brand X. I mean everybody is trying to get in this game right now and recruit. Everybody seize the opportunity, we're real happy with our results of those.

Donald Hultgren

You know Hugh right now in the marketplace, there's a lot of firms throwing around a lot of money. The upfront payments at some of the major wire houses are extremely high in the magnitude of may be at least two times trailing 12. We don't pay anywhere near that upfront. What we have to offer here is the culture. And today here are the things that have expired as the major firms' culture and a solid balance sheet looks pretty good to some people.

Hugh Miller - Sidoti & Co, LLC

Sure. Yeah, I am certainly hearing that the upfront money is becoming aggressive and then also I heard that some people are adjusting their trailing 12 to look back a couple of quarters to kind of compensate the advisor for the minimal production, the last several months?

Donald Hultgren

Yeah they are certainly not producing at full power right now that's for sure.

James Ross

Yeah we are starting to see deals based on average of the last 36 months production, I mean either there is every minute, there is a new deal structured depending. The competition is very high based on say, we look really good but there are awful of people out there.

John Holt, Jr.

Yeah Hugh, the way our model work just be the sales staff for a minute as the financial gap is that easily stretched over three year period as a earn out and look back. So even if the guy hasn't a past trailing 12 when we comes in within a year, he turns back and more back as the business returns.

Hugh Miller - Sidoti & Co, LLC

Yeah. And do you have a sense as the types of average production levels for the advisors that you're bringing on lately and where those may be are?

Kenneth Hanks

We've grown on a couple of multi-million dollar guys so that's really going to skew the numbers. I think what you're looking at right now is, the sweet spot for us is about 350 trailing 12 and today that was in the hard last 12 months.

Hugh Miller - Sidoti & Co, LLC

Okay.

Kenneth Hanks

But if you want to average what we've done this year, it's going to be north of may be right around six, but that's because we're seeing a lot of multi-million dollar position. I think that's going to stand for us.

Hugh Miller - Sidoti & Co, LLC

But you find that the 350 is the area where you guys are most competitive with brining on advisors?

Kenneth Hanks

350 guys are approaching us.

Hugh Miller - Sidoti & Co, LLC

Okay. I'll step back in the queue and let some other people ask.

Donald Hultgren

Thank you.

Hugh Miller - Sidoti & Co, LLC

Thanks.

Operator

Your next question is coming from Joel Jeffrey. Your line is open.

Donald Hultgren

Good morning Joel.

Joel Jeffrey - Keefe, Bruyette & Woods

Good morning guys, how are you?

Donald Hultgren

Good.

Joel Jeffrey - Keefe, Bruyette & Woods

Don, I know you talked a little bit about the clearing opportunities, but can you just give us a sense of... what do you think really gets that business going?

Donald Hultgren

Well I think as I mentioned in my comments that we certainly made a lot of changes there. We brought in really three new sales people who now have just over a year with us marketing our product. And it's my belief that it sounds like we're being what it is, that those guys today are starting to get some traction. And, so I will tell you that I am more optimistic about clearing that I have been in previous quarters, just based on the activity that seems to be going on with that sales force.

Joel Jeffrey - Keefe, Bruyette & Woods

So, should we expect to sort of see levels that we saw on the most recent quarters in the near term, or is it... are we closer to the end of the sales cycle I guess?

Donald Hultgren

I would say that things should improve. As Ken mentioned we only lost a couple of very large day traders, and we need to back and fill it probably what you're going to see as bring on and going to be general securities firms. But I think that the sale cycles, the sales efforts, I am very optimistic that it's going to be produce some results for us here.

Kenneth Hanks

This is Ken, if you think about the queries outside Joel, this is Ken or this is Don. If you think about the clearing as being very similar to our product client group add in the tenant contract that work and you'll see our revenue in that area was down so substantially in the quarter. You have to know that those clearing customer of ours were experiencing the same kind of hang in their own businesses, which business been laid down is not really producing any ticket. So they're kind of linked in that standpoint, so, I think as we think that this was one of the worst quarters for our retail, I think we would thank that it was probably one of the lowest volume quarters also for referring this.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay. You guys, I know just talked about that in the past, there are acquisitions in this area still on table for you?

Donald Hultgren

Absolutely. I continue to believe that there are a lot of people, who are in the clearing business were not core to their business. And I would say I'm proud to be coming nuisance in terms of the call that bringing to those people. In terms of trying to encourage that and to allow us to buy their clearing business. We will continue to beat the bushes and attempt to grow our clearing efforts through acquisition as well as organically.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay. And then just looking at the bank, how much... given that you guys down streamed about 15 million to the bank, how much excess capital is available at the parent or at the broker levels to continue to down stream if needed?

Donald Hultgren

Well, we have today about a... just over a 120 million in excess net capital. So the question is where does management want capital to be between the broker, dealer and the bank. We obviously had a 120 million and a wide flexibility in terms of that decision. So capital is not something that is going to keep us awake at night.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay, great. And then just lastly in terms of the net gains on principle transaction I mean that came in significantly above what we were expecting. Is this a level that you guys believe to be sustainable or is this -- was there a sort of anomaly in the quarter that drove at these levels?

Kenneth Hanks

Well I think it was our idea is the increase that you have in all the taxable fixed income activity. I mean the revenues in taxable fixed income were actually up in the March quarter greater than December quarter by a couple of million dollars in terms of commission and that really reflects on then the ability to earn trading profits as well.

Donald Hultgren

What we hear from management of our fixed income Joel is that, yes these are unusually robust times, but because some many of the other players are just gone from the marketplace, as a result of some of the activities in New York. Even if it wasn't an unusually strong period, we will expect it to settle out at levels above what we were accustomed to in the past.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay. And it may be in the Q, but I haven't seen it yet, but if you have any fundamental increase to you inventory levels at all?

Donald Hultgren

No I don't think so. I would say they're running pretty much where they've been. So no we haven't made a bigger commitment yet.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay, great. Thanks for taking my questions.

Donald Hultgren

Thanks Joel.

Operator

Our next question is coming from Edward Hemmelgarn. Your line is open.

Donald Hultgren

Good morning Edward.

Edward Hemmelgarn - Shaker Investments

Yeah Good morning. Yeah you're just I think I'll talk to you, but this is the past. But it's just when I looked at your the trends in your non-performing assets and loan loss reserves. I mean your non-performing assets are growing at a pretty significant rate and at a faster rate than your growth and your loan loss reserves. And it really looks... the ratio looks really bad compared to other banks out there. It kind of is very difficult to think about investing, because waiting for the other schuder fall (ph).

John Holt, Jr.

This is John. I'll comment on that. We incorporate a methodology for calculating our allowance for losses which historically has been very accurate. Additionally, we have modeled scenarios that actually double our level of current NPAs and double the charge-off rates and we're still well capitalized. So again I hope we're at a high water mark, but certainly you can't predict that with any certainty.

Edward Hemmelgarn - Shaker Investments

Well what has been your recovery rate on your... or what is your expected recovery rate on your non-performance assets?

John Holt, Jr.

Let me go, that the loss rate has been for the past six months 17%.

Edward Hemmelgarn - Shaker Investments

Do you have any non-performing assets that you've been holding for a while or?

John Holt, Jr.

No.

Edward Hemmelgarn - Shaker Investments

Okay. I guess it's just usually when you look at a bank, usually the idea is they try to get ahead of the curve.

Donald Hultgren

Actually we you follow our accounting guidelines and speaks strictly for that in terms of our methodology and again that over the history has been fairly accurate.

Edward Hemmelgarn - Shaker Investments

Okay. All right thanks.

Donald Hultgren

Thank you.

Operator

Our next question is coming from Steven Su (ph). Your line is open.

Donald Hultgren

Good morning Steven. Are you there?

Unidentified Analyst

Hey sorry about that. Hi good morning. So the loss rate that you just mentioned over the past six months of 17% how does that compare with your historical loss rates that you've seen?

Kenneth Hanks

Yeah, actually it's higher than historical, but if we went further back it would actually be less than that. But of course we would encountered unusual times. We had a year ago we had recoveries greater than offsets. So I mean if its real you've to give it, you really have to go back several years before you got in a more normalized loss history analysis.

Unidentified Analyst

Got you, okay. And then demand expanded pretty significantly at that bank. Is that would you cut out. What's the outlook for that, and the guys coming how should we think about that?

Donald Hultgren

I think it's pretty good Steven, because we've acquired historic rates or fewer rates in many instances on our credit. So ultimately, I think that we're seeing a much better spread and for at least the near term, we probably see that at least being where it is, may be even potentially going up slightly.

Kenneth Hanks

Yeah, but the movement is not right, starting in mid to late February, in terms of allowing us to get our spread back and so the average is that what you see the 4.8 as an average for the quarter, which we really have the better rights during the last half of the quarter. So I am expecting to see it go up more in the second quarter.

Unidentified Analyst

Great. And are there any more of levers to pull in terms of reducing the cost of funding on the bank side there?

Donald Hultgren

The cost of funding?

Kenneth Hanks

Yeah it's pretty not allowing, that the majority of it is funded at the base about a rate of 23 basis points.

Unidentified Analyst

Okay.

Kenneth Hanks

So, and then a start up fee.

Unidentified Analyst

Okay, great. Thanks for taking my questions.

Donald Hultgren

Thank you.

Operator

Our next question is coming from Hugh Miller.

Donald Hultgren

Welcome back.

Hugh Miller - Sidoti & Co, LLC

Hi, just had a couple of quick follow-ups. Looking at the clearing obviously you guys have talked about the search for an acquisition. I was wondering when you're thinking about that what really is the target that you're looking for and the type of correspondents that the other institution would have and the type of business that you are looking for here?

Donald Hultgren

Sure. The most attractive to us would be Federal Securities Firms. As you know, our agenda in clearing is to unleash the operating leverage that is there. And so our clearing platform is a domestic platform. So, we would not be looking for examples for somebody who did a lot of international clearing, somebody who cleared a lot of futures. We are looking for general securities firms, that'll do in stocks-bonds options that kind of thing.

Hugh Miller - Sidoti & Co, LLC

Okay. And I guess and looking at the capacity I know that there is ample room for substantial increases especially from these levels. Can you give us I guess a sense of where you think you can max out from the transaction's process I guess with the current capacity?

Donald Hultgren

Well, its our believe that the capacity today, we're running at may be 15% 20%, of what we could do without having to maintain huge changes. And may be we got to add more servers to do that. But, its there is quiet a better room there Hugh, for at least we have to start worrying about whether we're going to run out of steam.

Hugh Miller - Sidoti & Co, LLC

And looking at your sequential contraction in the number of total employees, I know that you guys are expanding at the bank having the hiring opportunities at the retail brokerage. Can you talk about I guess what areas the reduction was mostly in and the plan on a go-forward basis?

Donald Hultgren

Yeah, what you saw was we did a... with a market at the bank as it was, it was logical that we would go through and look at our cost structure in the bank which we did. And again, we are still in a process of stimulating the M.L. Stern acquisition and there continues to be opportunities there for us to get some cost efficiencies as well.

Hugh I might go back if you allow me, we're talking about how much we could grow clearing and that was pretty much open ended, one of the things that we're excited about is the management team is that when you look at the marketplace for brokers or bankers and for clearing customers, our ability to grow in all three marketplaces is pretty much open ended. And so we're running around here like we're on paper hanger.

Hugh Miller - Sidoti & Co, LLC

Okay. And, yeah I appreciate the insight there. And I guess one last question just looking at the institutional brokerage business and obviously you guys have had a wonderful opportunity to gain market share as some of the larger peers have dealt with the issues there. But I guess what do you guys see in the timing of how things play out and obviously as those larger peers do eventually solidify their balances sheets and start to look to become a little bit more aggressive with regaining some of that business.

What type of timeframe should we be looking at? I mean you'd mention that you expect things to kind of eventually level off at higher levels than they had been historically. But how should we be thinking about things in terms of where do you see competition really starting to come in more aggressively over what time period?

Donald Hultgren

Well I don't know it's necessarily going to be competition as much as it's going to be the volatility in the marketplace and its spreads. I mean, I think, the completion, I mean, Lehman's gone, Bear Stearns is gone, Merrill Lynch is gone. I really don't see them coming back. And so, a lot of those people who were there have taken jobs in others firms and so I think fundamentally the marketplace has changed.

I don't it'll ever be the way it was. But I would expect that at some point, the U.S. volatility and the spread and of course at some interest rates will probably go up and then Ken can stop complaining about the net interest income in all of our other businesses. So there will be cyclical changes, but structurally, I think it's a permanent change.

Kenneth Hanks

We have a couple of questions also from the Internet as well.

Hugh Miller - Sidoti & Co, LLC

Okay. Thank you very much for answering all my questions.

Kenneth Hanks

Thanks Hugh.

Donald Hultgren

Thank you.

Kenneth Hanks

One of the questions from the Internet is what about stock repurchases during the quarter?

Kenneth Hanks

There were no stock repurchases during the quarter. I think our policy... we only have a policy but our past behavior has been a little when we see stock below book we'll take advantage of it. But I think during these types of the market everyone's talking about keeping their capital with them (ph).

Donald Hultgren

Yeah I would say that this is a little bit unusual from the standpoint that in prior years we paid unusual dividends, we have brought back stock. Well I tell our ability to use capital to grow in this market is a really exciting opportunity and so I think there frankly are better uses of our capital today to grow the broker and grow the bank than buying back the stock.

Kenneth Hanks

I'll talk to you at this afterward. There are other questions Don, one of the questions is, I was under the impression that you wanted to limit the capacity of the mortgage purchase business that it keeps growing, what is the rationale for that. I guess I saw it return.

John Holt, Jr.

No, (ph) this is John. How are you?

(Multiple Speakers).

John Holt, Jr.

I'll answer the question. The mortgage purchase business we've put a $300 million cap internally on that business. And so the outstandings are typically at the end of the quarter and so that 297 that is at the end of the quarters of that where we target that number. And so the further question was $15 million was down streamed into the bank, and where the regulators recommending with additional capital with the internal decision. And it was clearly incumbent decision to support the growth as we added these new banking centers and teams of bank and the teams of bankers we needed the capitals here to grow that.

Donald Hultgren

Yeah, we emphasized that John everybody is caused about down streaming, actually and I look as down streaming with capital, but the capital that one stands at the bank was definitely set to support the grow. And if we... as I said we continue to see the bankers that we've hired recently, I'm bringing very good loans obviously with good interest margin and we will continue to fund that growth.

Kenneth Hanks

But the capital is one step to the bank for the growth was not for more of purchase growth. It was fit for other loan growth, just to clarify that part of question?

Donald Hultgren

Commercial loan?

Kenneth Hanks

Right.

Kenneth Hanks

Thank you John.

Donald Hultgren

Okay. I guess that we have exhausted the questions. Again I want to relate to you how enthusiastic the management team here is with the opportunities that we have to grow our businesses in this market. It truly does appears being in unusual times and exciting time. And again I want to thank our employees, who are working so hard to help us grow and we look forward to talking about our progress with you in the next quarter. I hope you all have a great day.

Operator

This will conclude today's conference. All parties may 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!

Source: SWS Group F3Q09 (Qtr End 3/27/09) Earnings Call Transcript
This Transcript
All Transcripts