Fortress Investment Group LLC Q3 2009 Earnings Call Transcript

Fortress Investment Group LLC (FIG)

Q3 2009 Earnings Call

November 6, 2009 8:30 am ET

Executives

Lilly Donohue – Investor Relations

Dan Mudd – CEO

Dan Bass - Chief Financial Officer

Wes Edens – Principal and Co-Chairman of the Board

Pete Briger – Principal and Co-Chairman of the Board

Mike Novogratz – Principal and Director

Analysts

Roger Freeman – Barclays Capital

Dan Fannon – Jefferies

Roger Smith – FPK

Presentation

Operator

(Operator Instructions) Welcome everyone to the Fortress Third Quarter Earnings Call. It is now my pleasure to turn today’s call over to I will now turn the call over to Lilly Donohue.

Lilly Donohue

I just want to welcome all of you to our third quarter earnings conference call. Joining me today is Dan Mudd, our CEO, Dan Bass our Chief Financial Officer, and we also have with us today Wes Edens, Pete Briger, Mike Novogratz.

Before I turn it over to Dan I just want to point out 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 statement. 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 disclosure in our quarterly earnings press release, including a recommendation to review the risk factors that are contained in our annual and quarterly reports that are filed with the SEC.

With that, I just want to turn it over to Dan.

Dan Mudd

I’m going to review the market and the company’s performance and then Dan Bass will go through the financial in some depth. As Lilly noted, Wes, Pete, and Mike are also here to discuss the specifics of their businesses.

I think the overall theme for the quarter and probably also for the year to date is continued positive trajectory but more to do. Assets under management at $32 billion which were up $1 billion from the second quarter, pre-tax DE was $57 million which is up from a loss of $20 million in Q3 ’08. I think notably we also had a solid quarter of fund performance, macro fund year to date is up 19.5%, special opportunities 18.2%, and private equity valuations are up as well.

A little sense for you in terms of the themes that we’re seeing here, the quarter reflected a lot of the issues that we’ve seen developing in the course of 2009. The global markets remain choppy and while there is increasing transactional liquidity a lot of questions seem to us to be still unanswered in terms of the shape of trade or regulation or fiscal policy. Employment you saw the numbers that were just released, if I were to name a few bumps in the road.

As a result of all that I think the overall economic indicators are not robust even though they’re more linear then they were a year ago. We see investors cautiously putting some capital back to work. The S&P 500 cemented its second consecutive quarter of double digit gains, up 15% in the quarter but still a long way to go from the peak back in ’07. Equity and debt markets are opening up credit worthy companies albeit not to others.

We hear observations that things are bottoming out but we think that those observations, those observers, lack conviction. Our thought here is that the healing and the recovery of the markets, the effect the government policy and the resulting macro economic outputs are going to be uneven and they will vary widely by sector and geography and timing. At some level all of that unevenness should play out to Fortress strengths as a firm and we’ll look to take advantage of those anomalies. In other words, in a messy world we can find and finance and profit from opportunities where more traditional asset classes would like a less messy proposition.

On that, a few comments about our strategy as an alternatives manager in the messy world. If you start with what we know the great de-leveraging of 2008 led to the great liquidation of 2009 and we’re now seeing companies sold, assets trade, people move. Along with the great liquidation we had the great intervention with government supporting housing, owning banks, auto manufacturers, and intermediating between the US consumer and the Chinese factory worker.

We think that after that great de-leveraging and the great liquidation and the great intervention we may have the great taxation and the great litigation, more to come. There are also some things that we don’t know, will governments be able to strike precisely the right balance between inflation and deflation, will they be able to adroitly remove federal ownership of corporate equity, and will the dollar, the RMB, or gold provide the world’s reserve money.

I would say that being a CEO at Fortress confirms my views before I came here. We see a mess as an opportunity and this great liquidation, great intervention, great taxation, great mess; all promise a good stream of opportunities. After all the gloom and doom I think we may be going into a golden age of alternatives and in the balance hangs the $200 trillion of investable assets around the world. Our job as an alternatives manager is to prudently deploy that capital into messy markets by sourcing and funding transactions and positions that are out of the mainstream.

In our global macro business this golden age expresses itself through imbalances in currencies, commodities, and securities which are as large as they’ve ever been. Over time, the imbalances will correct through government policy or private capital flows and the correction process gives us the opportunity to trade on the direction of prices in the relative important sub-sectors. There’s now ample liquidity in these markets to trade but there’s so much dispersion that Mike’s business can take a view and profit from that view.

In our PE business and our credit funds we operate in the private capital market and we think that the discrepancy between public market valuations and the private market has never been this wide. Three years ago there was really no illiquidity premium for being in the private market versus the public market and now it’s reversed and that premium is so big that there are virtually no transactions. If you can source those transactions that there are with fundamental asset value you get paid for providing the liquidity and if you can fund a holding period for the longer term such as you’d have in a PE structure you can monetize the premium.

Accordingly, our private equity funds are up from March and been able and discrete transactions like the Rail America IPO to tap the markets. Our credit funds have been a big beneficiary of the messy environment as individual assets and larger portfolios have come out of troubled capital structures and Fortress has stepped in as an acquirer manager.

We talked about Zoron last quarter and continued the approach with an investment in AIG’s private equity fund and the debt for control investment on Sheffield57 here in New York.

On the liquid hedge fund side performance has been quite strong. As you know, high watermarks vary from investor to investor but we’re now within a range of around 5% to 8% of the high watermark in our global macro funds.

Point one, there’s positive trajectory but point two, there’s more to do and it falls into three categories:

Performance

New Capital

Corporate Development

Performance we need to obviously continue to produce positive returns in our existing funds, meet our high watermarks, and we hope that will happen in the first half of next year.

Second, accessing capital, we have started to attract and see fresh capital and fresh names in our business. The Asia fund continues to grow, our liquid hedge funds just took in two large institutional accounts and we anticipate another closing for our credit PE business before year end. I will say with that though that the capital raising environment is very different from a few years ago. The process is longer, investors are more cautious, allocation methods are under review. We’ll need to continually and steadily raise capital so that we have something to deploy into that golden age of alternatives.

Finally, at the corporate level, we’ve been spending a lot of time thinking about how to grow and diversify Fortress at the corporate level. The traumas of the past couple of years have left a wide range of opportunities to invest in or work out other firms. We have come across attractive business units that would be complementary to our scope of activities. They’ve got good teams, they’ve got good management, they’ve got good track records but they’re often trapped in a corporate organization structure that’s not sustainable. We’re looking at those and where we can be disciplined and measured and conservative we’ll try to move forward and we’ll keep you updated.

As for my role, I’m glad to report that things have been as advertised, focusing on the day to day management of company while Wes, Pete, and Mike focus on their investment businesses. I’ve also had time to meet with many of you in one on one or small groups that are in the analyst community. One common theme is, we’ve taken it to heart, you’ve asked us to kind of improve our user friendliness so we’re re-looking at our disclosures, our transparencies, key metrics, our website, and I guess generally how we tell the Fortress story. You’ll be seeing upgrades from Q4 going into 2010.

A little bit of detail on the quarter. First, assets under management which refers to the amount on which we earn management fees, the key driver of our revenue line, as noted AUM was up $1 billion to $32 billion and up 21% from our low of 26.5% at the end of March ’09. Second, the performance of our funds, which influences both our management fees and our ability to earn incentive fees, is a second measure that we look at. Pre-tax earnings is our measure of earnings available for distribution. Pre-tax DE was $57 million up significantly from a loss of $20 million in the third quarter of ’08. Pre-tax DE at present is overwhelmingly composed of base management fees but as we reach our high watermarks we can expect incentive fees to kick in again.

Fortress principal investment portfolio, the investments that we own on our balance sheet is up about 8% since the last quarter due to the positive performance of the underlying funds that we manage. The corporation, as you know, invests side by side with the LPs, as you heard earlier we’ve had positive hedge fund performance and increased valuations in private equity.

A little more into the businesses and then I’ll turn it over to Dan. In liquid hedge funds we’ve got $4.5 billion of capital, about $3.6 billion on our macro funds and $900 million in our commodities fund with continued positive performance during the quarter and year to date we’re starting to see new names come into the funds. Mike and Adam have made significant progress on earning back the funds high watermark. At this point global macro funds are up 22.2% and have a range, as I said, depending on the particular investor, within 5% to 8% to get back to the high watermark.

Moving on to credit, our credit funds ended the quarter with $13.2 billion of assets under management up from $12.7 billion last quarter and up significantly from the end of March of $8.5 billion. The increase in AUM was primarily driven by new assets under management and improved performance. Here is where a lot of this great de-leveraging and great liquidation plays out and we have a significant competitive advantage in our ability to acquire or work out assets from non-core or distressed owners and we’re starting to see that in our recent investment.

We talked about the AIG transaction where Pete’s team was able to invest in AIG’s publicly traded private equity firm. They faced a lot of liquidity challenges in the investment enabled them to stabilize and restructure. We earn market rates on the credit facility as well an equity participation in the upside on their business.

The main credit hedge fund in Pete’s business had a good quarter; it was up 6.8% net. This brings the total return for the fund up to 18.2% for the year at the end of September. While we haven’t finalized the numbers, that trajectory continued into October. The credit private equity funds suffered valuation declines in the last quarter of ’08 but have rebounded this year and are currently valued north of 1.4 times invested capital.

On the new capital front there we’ve had additional closings in our Asia fund during October bringing that fund to a total of about $450 million. Also worth mentioning, our investment team in Japan continues to grow and in September with our partner Nomura we hosted the first never alternative investment conference there, we had 130 participants from 60 different institutions which I think is an indicator that Asian investment in alternatives is increasing. In light of the expectation that the economic recovery in Japan will lag we bound a burgeoning of interest in both macro and credit strategies.

On to private equity lastly PE saw continued progress in the quarter, AUM was $14.3 billion up from $13.8 billion in Q2. Our initial private equity investments less realizations equal $10.4 billion and are marked at $10 billion as of September 30 so pretty close there. Focus for the past couple of years in PE has been all about financing the operational performance of our companies. Valuations, as you know suffered in our portfolio in the past year so we’re pleased with the progress but clearly have a ways to go in generating the returns that we expect.

Importantly we’ve refinance about $6.1 billion of debt maturities in the last 12 months and over $15 billion since the third quarter of ’07. At this point we have one significant short term debt maturity in our private equity portfolio and are working on that. Importantly as well, the underlying operational performance from the portfolio companies has been positive. By company we do have significant out performers like our senior living business, the German residential business, our US loan servicer, but we also have several that are challenged, one example being in the travel and leisure section.

As I mentioned, finally we successfully completed the IPO of Rail America, the short line railroad company which was our first IPO in two and a half years. Mr. Buffet must have noticed that and we noticed as well, railroads moved 43% of the country’s freight volume and are the most efficient form of ground transportation out there today.

To summarize, continued positive trajectory but more to do. Looking ahead I think the business is well positioned for the messy environment we see. Our deal flow is very good. My colleagues here at Fortress have operated in tough environments before and I think in general investors are taking a more positive view of the alternatives sector.

Thanks for listening. I’ll stop there and turn it over to Dan for his comments.

Dan Bass

As Dan mentioned, we continue to move in a positive direction during the quarter, gaining traction and new capital raises, performance of our funds were up across the board. Our financial results were stable, a testament to the long term natures of our funds capital. Finally, the firm’s liquidity continues to improve while we’ve been right sizing the components of our capital structure.

Our earnings measure pre-tax distribution earnings was $57 million for the third quarter and if you assume a 25% tax rate was approximately $0.083 per share. This result was $2 million lower then the second quarter this year mainly due to a slight increase in revenues offset by a slight $3 million increase in expenses. The result was a $77 million increase over last year. Fund management DE which was our measure of net fee based operating results was $51 million and our principal investment was $6 million for the quarter.

As I discuss these results in more detail I want to focus on the following key measures, drivers that drive our business:

For fund management DE these are assets under management and performance of our funds as well as operating margins.

For balance sheet it is the performance of our principal investment portfolio.

Starting with fund management DE which again is $51 million for the quarter, this result consisted of $118 million of segment revenues against $67 million of expenses resulted in operating margin of 43% for the quarter. This is equal to our average margin for the first nine months of the year and is in line with our targeted operating margin. Fees results are a reflection of the continued improvement we have had in the performance within our funds.

First, assets under management is influenced by the performance because it directly increases or decreases the value of our funds existing capital and is a significant factor in the inflows and outflows of capitals to our funds. Fluctuations in assets under management directly affect the management fees we earn.

Second, performance enables our funds to reach and exceed their high watermarks or realize embedded profits and therefore pay us incentive income. As noted in our press release, all performance measures for our hedge funds are up for the quarter and for the year, most notably our credit hedge fund was up 6.8% for the quarter and our Fortress macro fund was up 3.6% for the quarter.

All of our hedge funds entered the year carrying losses that needed to be recovered to reach their high watermarks and all have made considerable strides toward recovering these losses during the year. In fact, approximately 15% of the capital in our macro funds at 9/30 is above its high watermark and we recognized $2 million of related incentive income during the quarter. Additionally, as Dan mentioned, the balance of the macro fund is within 5% to 8% of reaching its high watermark.

All the capital in our commodities fund reached its high watermark during the quarter and we earned approximately $6 million related incentive income in the quarter as well as both our private equity and hybrid PE funds on an aggregated basis saw 10% appreciation during the quarter. By the end of the quarter AUM increased to $32 billion. During the quarter AUM, $1.2 billion of the increase was due to positive performance within our funds. $1.2 billion breaks down about half in our private equity business, $400 million in illiquid hedge funds and $200 million in hybrid funds.

For the quarter we also raised capital in a number of areas, however, overall redemption payouts exceeded the inflows. Within our hybrid segment approximately $300 million was raised in the Japan distress fund and our new credit opportunities funds and this was partially offset by $100 million of payout from our slow pay accounts in the credit hedge funds.

Within our liquid hedge funds our Fortress macro fund and commodities fund had inflows of $200 million during the quarter which was offset by a $400 million payout of the continuing liquidation of the SPV and $300 million of regular liquid hedge fund redemptions.

On the operating margins front it is important to note that as an investment manager the majority of our expenses are related to compensation. We have a variety of compensation structures such as discretionary bonuses, profit sharing arrangements and stock ownership that enabled employees to participate in our performance. All these structures are intended to retain the best talent but also provide us flexibility to align our expenses and our employee’s incentives with the performance of the firm. In the end, our goal is to retain our targeted operating margins that are between 40% and 50% based on management fees and incentive income we are generating.

Now let’s shift gears to our principal finance segment. DE for the quarter was $6 million unchanged versus second quarter this year, $6 million was largely comprised of $12 million of marks on our hedge fund investments down 2% from the last quarter and $4 million of carrying costs on our debt. That’s a $4 million decrease from the prior quarter mainly due to our lower debt levels.

As I noted earlier, performance of our principal investment portfolio, which is mainly comprised of investment in our funds, drives the result of this segment. The increase and decrease in value of our investments affects either the short term earnings from our hedge funds or the long term ability for us to cover our invested capital and realize income on our private equity investments.

The portfolio stands now at $869 million. It’s consisted of $674 million of private equity assets, $124 million of hedge fund investments, and $71 million of publicly traded securities. Overall, our assets increased $67 million or 8% during the quarter, $56 million of this increase was related to the private equity and publicly traded securities. It is important to note that these amounts do not run through principal finance distributable earnings on a current basis but will only be recognized when we realize the income.

As of September 30 we had approximately $110 million of embedded private equity gains on a DE basis in our portfolio. The majority of the remaining increase was related our hedge fund investments which is reflected in the $12 million result I mentioned before.

In the current quarter we also continued our focus on liquidity position in debt reduction on our balance sheet. We paid down $28 million during the third quarter and subsequently paid down $14 million in October. This brings our total debt outstanding to $398 million and net of approximately $160 million of cash on hand today we have total net debt of $238 million.

Finally, as it relates to taxes for DE purposes, as of now we are estimating that our 2009 effective tax rate will between 24% and 27%. However, this estimate is sensitive to the changes in our forecasted income for the balance of the year.

With that I would like to thank you and we’ll turn it over to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Roger Freeman – Barclays Capital

Roger Freeman – Barclays Capital

On hybrid private equity you had what $1 million incentive fees there and you had $160 million in realizations? I’m curious I guess I would have thought maybe you’d see some more performance fees there because that is the credit fund right? That’s done fairly well?

Pete Briger

That payout and recognition of income there is on an as realized basis. What we talked about was an NAV as opposed to realizations. The realizations at this point have been quite limited.

Roger Freeman – Barclays Capital

How has that distressed credit fund done? I think it was up something close to 30% in the second quarter, how’d it do in the third quarter?

Pete Briger

I think that its up close to 100% on the year, I may be off by a couple percentage points but its done very well, I think we’ve been positioned correctly.

Roger Freeman – Barclays Capital

Has that been predominantly resi?

Pete Briger

I think that we’re not going to talk about our specific positions in the fund. The specific number that US for in the quarter it was up I think 35% in the quarter.

Roger Freeman – Barclays Capital

With respect to some of the distressed operating more broadly we’ve heard from other alternative managers that there’s an increased appetite on the part of banks to sell down some of their residential whole loan exposures particularly because they are generating stronger operating income and it allows them to take some of those marks. Are you finding that to be the case or are you buying portfolios or loans from banks now?

Pete Briger

We are buying portfolios of loans from banks and other financial institutions. I would say at this point regulated financial institutions that are solvent are not selling significant portfolios of debt. Most of what we’re seeing right now is out of the shadow banking community out of bankruptcies and other types of liquidating entities. I would expect that the sell off of assets from solvent financial institutions and institutions that are being taken over by the various governments will steadily increase very quarter for the next two or three or four years.

Roger Freeman – Barclays Capital

I guess you’re in the process of raising money for a new fund. Have you had a closing on that, can you tell us much you’ve raised so far?

Pete Briger

We can’t comment on marketing of funds.

Roger Freeman – Barclays Capital

The commodities fund how much above the high watermark is that? I’m trying to figure out in the quarter are we looking at a run rate of performance fees relative to the return there or did it pass late in the quarter?

Dan Bass

The commodities fund has always been above the high watermark. It was up roughly 8% last year and roughly the same this year, year to date. That’s been a constant contributor on that incentive fund.

Dan Mudd

The entire amount is above its high watermark.

Roger Freeman – Barclays Capital

I thought there was a comment that it has passed the high watermark because there were no performance fees recorded prior to this quarter.

Dan Mudd

For the first part of this year it was not above its high watermark it just broke through in the third quarter.

Roger Freeman – Barclays Capital

How was it below if it was up last year?

Dan Bass

We clip incentive on a quarterly basis so the last we clipped was late last year. There was a dip, it was still up for the total ’08 and then we recovered that dip in the third quarter this year.

Roger Freeman – Barclays Capital

In private equity can you, obviously IPO’d Rail America maybe first on that one can you give us a sense for maybe what your cost basis is, obviously the stock hasn’t done well since the IPO I assume your cost basis is significantly below where it is now. More generally speaking, how do you think about opportunities elsewhere in the portfolio, you’ve got a servicer I assume that’s doing pretty well, and thoughts on the IPO market in general we’ve seen activity but performance has been soft.

Wes Edens

The Rail America our cost basis is well below its stock is and we raised some capital both primary and secondary basis so the real primary motivation for that company’s IPO was to get it into the public market and get some capital in because we do see lots and lots of terrific opportunities in that space. That company has done really tremendously during a pretty soft economic period. We think given any kind of tail winds at all from the turnaround here it’ll do terrific. It was the right reason to get into the markets was to generate some capital for it; it was successful in that regard. Obviously it didn’t trade initially like we had hoped it would but that’s going to be a public company for a very long time and we think the prospects for it are great.

The other portfolios there are a number of companies that fall into similar characteristics. You mentioned the servicing business has been one of the real stars of the portfolio, that’s something that we invested in a number of years ago and it was both an originator as well as a services. We had shut down that origination business when the crisis first hit two plus years ago and really focused on the servicing business which has been really a homerun. The opportunities there seem limitless. That is something that we are definitely looking hard at different kinds of alternatives and different kinds of opportunities and I think that there will be more to come from that sometime in the first part of next year.

Other parts of the portfolio that have actually done quite well which is a little surprising perhaps given the economic background is a lot of the transportation businesses. The airplane business which will report results here shortly has had a really a tremendous period. The container business, especially refrigerated containers and the like has done very well. There are actually lots and lots of individual company performance that has been exceptional and where we think it makes sense is access incremental capital the IPO markets are a very viable form of that. I think its going to be an active period for us next year with regards to that.

Roger Freeman – Barclays Capital

Now that you’re focused full time on private equity again focusing efforts for new investments I know banks were an area of interest to the FDIC hasn’t made that particularly amenable for private equity. Where do you think opportunities are right now?

Wes Edens

Its interesting we had our private equity fund conference a couple weeks ago and that’s always a great occasion to try to take and get some good summary statistics, look back on where you were over the past year and guess where it might be over the next year. The one comment that I would make is that it seems very clear to us that much of the financial services opportunities still lie in front of us. Even though you had a terrific amount of capital raised for the handful of the biggest banks and that’s an important cornerstone of the economy.

Many, many of the smaller banks, many of the non-banks still have very significant liquidity issues and financing needs and the market is just not that robust for a lot of the financial institutions. I think this is something Pete’s been very focused on and I’m now focused on a different context. I think a lot of the opportunities are going to come out of the financial sector in the next one or two years.

Roger Freeman – Barclays Capital

If you could comment on liquidity provision shore us capital base is without outright purchases of control where you used to run into some of the regulatory issues.

Wes Edens

The government has made it pretty clear that they are at the least cautious about how they want to allow capital to come in the sector and how that plays out I think you have to come. They certainly have moved to the speed which is slower then what I would have guessed a year ago. Having said that, there’s lot and lots of ways to express an investment in that.

Operator

Your next question comes from Dan Fannon – Jefferies

Dan Fannon – Jefferies

On the hybrid side I wanted to talk about the $1.5 billion in redemptions that you disclosed that have been put in for the end of the year and wanted to see, can that grow before the end of the year or has the notice period for those redemptions been closed?

Dan Bass

That is closed, it’s a once a year notice 90 days before year end. That day is done so there’s no opportunity for notices the balance of the year.

Dan Fannon – Jefferies

Should we anticipate you setting up another SPV to fund those over time?

Dan Bass

No, this is the normal redemption characteristics of the fund is it’s a private equity payout structure that’s how that fund operates, there’s no creation of SPV that’s just how that fund operates.

Dan Fannon – Jefferies

Can you refresh us on what is remaining in the SPV you set up last year?

Pete Briger

Just to be very clear about it, there was no SPV, no gates set up in the hybrid business whatsoever. I think what you’re referring to is the macro if the question is directed at our liquid markets business we’d be happy to answer it. There was no SPV or no change of the redemption provisions in the hybrid business.

Dan Bass

The SPV on the macro side to date we’ve paid back 67% of the capital. By year end we will pay back more then 100% of the capital. The return on that from the initial capital has been up about 33%.

Operator

Your next question comes from Roger Smith – FPK

Roger Smith – FPK

Can you first talk about the TALF opportunities that are out there and what you guys might be thinking about in that space?

Pete Briger

We have not participated as a buyer of securities in the TALF program. I think that’s been a valuable program for the country, it’s been a positive in terms of bringing liquidity back. For us, we’ve been able to find more attractive opportunities elsewhere. We may seek to avail ourselves of TALF financing structures within our portfolio companies as an issuer

Roger Smith – FPK

If we talk about the servicing company could you guys maybe give us an idea of how the HAMP program is affecting that business?

Wes Edens

The HAMP is in full flight in the servicing world and there are a lot of modifications being done. Our own servicer signed up the directive on HAMP a number of months ago and it’s been one of the most active parties in providing modifications. I think from our perspective it has been successful to date but that is a qualified success because it’s very, very early in the program.

I think one of the things that it does still not address in a material way is a reduction of principal which I think would have a very meaningful impact on servicing and ultimate performance in the borrowers and true debt release. That’s something that we have some thoughts about. The HAMP program as it stands does not actively contemplate that. You’ve seen a number of borrowers now move from the trial period into the actual HAMP program itself and I think the numbers have been successful bit its just way, way too early to say anything that definitive.

Pete Briger

While the HAMP program has been a positive in terms of increasing servicing fees, i.e. the government pays us for every modification that’s done, quite a hefty sum. We do think that there are lots of problems with respect to the HAMP modification program, most notably the equitable treatment of senior and subordinated debt which has not been addressed thoroughly in our view.

I think at this point there still remain significant issues with respect to the governments’ modification programs on mortgages which will need to be more thoroughly thought through, implemented, and executed for us to move our way past the current mortgage crisis, bring mortgage finance back in a bigger way in a non-governmental way. I think right now it is too early in almost every respect to call the government’s mortgage modification process successful.

Dan Mudd

The program so far has involved a lot of adjusting and restructuring, extending, tinkering along the way which to your original question about the servicing business is a good thing because we get paid for doing that work. More broadly I think in order to staunch the flow Pete’s exactly right that a unified approach to principal reduction to get people on a footing that they can actually sustain instead of becoming serially restructured in the process will make a lot more sense.

Roger Smith – FPK

Back to the redemption of $1.5 billion that was only an incremental change from the last quarter wasn’t that at one point $1.35 billion at the end of the second quarter, that’s how I should understand that?

Dan Bass

No, the credit hedge fund has a once a year notice period that comes at the end of the third quarter. That’s the amount this calendar year.

Roger Smith – FPK

Wasn’t there a $1.35 billion of redemption requests last quarter on that fund?

Dan Bass

Last year.

Roger Smith – FPK

If you can give us anything else on that acquisition strategy that you talked about. I want to make sure that I’m understanding it from a thought process, is it really businesses that are extensions of the current business that you’re doing or…

Dan Mudd

There are two ways to think about it. If you think about the structure of Fortress we have three businesses in a corporate structure and the businesses kind of operate in a vertical, the PE space, the credit PE space and the liquid markets group. My sense is that we are very well covered from a depth standpoint in those businesses. When transactions come up in the appropriate field we’re able to look at them, we’re in the deal flow, we can look at them and we’ve talked about examples of those whether expanding into a commodity fund or DB Zoron or Rail America IPO all of those sorts of depth transaction.

Also at the same time at the corporate level there are asset management businesses that are analogists to what we do. They may be in a different class of assets or a different class of securities that are reasonably sized so this is not a long ball approach but rather a continuing to concentrically expand the scope of asset management activities that Fortress is in.

If you think about what’s going on, we did all this great de-leveraging and great this and great that and the other thing but there’s also a great restructuring going on and lots of large organizations think of banks or insurance companies are selling things perhaps for economic reasons, perhaps for political reasons, perhaps for some other reason. In the course of that the business itself is unimpaired, good management team, good track record, a sector that we like. An example we see, we see over the longer term a lot of wealth moving into the fixed income world to areas that are related to what we do, high yield hybrid would be a couple of examples.

In certain circumstances there are businesses that are in larger corporate structures that are not going to be able to remain in those corporate structures and we’re taking a look. The way that I would think about it would be that the strategy from a growth standpoint is depth for the businesses that we’re in and breadth in analogist reasonably sized, prudent, conservative businesses that we’re not in.

Operator

Your next question comes from Roger Freeman – Barclays Capital

Roger Freeman – Barclays Capital

There’ve been several sales of asset managers basically to your point, financial institutions that had to sell to raise capital, TARP issues etc. Is there still much of that left and is it most, it’s been mostly long only because its traditional institutions that are not running alternative or very plain vanilla types of investment managers. I’m trying to get a sense for basically what you’ve been looking at? What is that opportunities that really likes, how much distressed sale pressure is there still right now?

Dan Mudd

I think it continues. I can tell you that during the first couple weeks that I was in this job I got a lot of blue books from investment banks around town that indicate the proposition that a lot of these assets are going to trade. In some cases from a position of strength and in some cases not from a position of strength.

There are two interesting levels of nuance to add to it. On one hand I talked about the businesses that are manageable on both on sized transactions. The other thing though we talked a little bit about servicing. One of the strengths Fortress has is we’re not afraid of these messy situations and we have servicing businesses, Pete’s got one in Spain now, Wes’s business in Italy, folks that are doing research in the financial services sector.

On one hand we have the ability to look at the assets and on the other hand we have the ability to service them and/or earn a stream of fees coming off of managing those assets. The simplest way to think about it is a self contained company that is a division of a bank and there’s a reasonable deal flow there. There is also another underground pipeline of businesses that in a different form and structure could be managed differently so you could be buying assets or you could be buying a serving company or you could be buying both and having them sit in different places, whether in one of the LPs or at the corporate level depending on the nature of what they do.

That’s probably about as far I should go into it until we have some transactions to announce. We did create a unit here, think of it as a business development unit, to focus on being able to pursue those transactions because we think there’s enough of a pipeline that will last long enough that we should work on it and make sure we don’t miss an opportunity to build out the future.

Roger Freeman – Barclays Capital

Tied to that, like wind down types of opportunities maybe legs weren’t but maybe similar not necessarily taking on assets from an asset manager but out of an institution that needs to work out of a portfolio more of those types.

Dan Mudd

I think my operating principal is that if a transaction can go into one of the existing business units that’s where it should go and if it’s a bit of a diversification or an expansion of scope then it may be more appropriate at a corporate level or not at all. We’re not chasing the fire engine. Pete can comment more specifically on those types of transactions.

Pete Briger

I do see that as a huge opportunity over the next five years. You, I think, are going to see more financial asset liquidation and more non-core business sales out of both solvent institutions and insolvent institutions over the next five years then you’ve seen in the sum total of the last 100 years. There are lots and lots and lots and lots of the shadow banking system and the regulated financial institution world that’s going to be sold onto the marketplace to buyers who are going to either mop up the servicing of those assets acting as a fee for service provider or entering into I guess for lack of a better term, RTC like transactions where you’re buying portfolios of assets and servicing those.

Really, as I mentioned before, just starting right now, I think people don’t really understand the full amount of what is going to transpire but it should be the world’s greatest supply/demand imbalance.

Roger Freeman – Barclays Capital

In the traditional hybrid hedge funds there’s $121 million of negative, I forgot what the line is, I’m trying to reconcile, you had a positive return in all the funds that you list yet if you work from beginning to ending AUM you’ve got $171 million of total new capital came in, $137 million of redemption, and $121 million of other loss. I think its FX and other operating losses. I’m trying to figure out where the positive return fits in there to get to the ending AUM because it’s actually below where it was in the last quarter.

Dan Bass

The main credit hedge fund was up DBSO that’s offset. We also included an AUM for that business, the Zoron portfolios that we took over that’s where you see the negative.

Roger Freeman – Barclays Capital

That’s just a liquidating portfolio you’re seeing coming through there?

Dan Bass

Yes. It’s in our hedge fund structure.

Roger Freeman – Barclays Capital

The rest of hybrid what was the return on that in the quarter?

Dan Bass

On the special ops fund it was up 6.8% for the quarter.

Operator

At this time there are no further questions. I would now like to turn the call back to Ms. Donohue for closing remarks.

Lilly Donohue

We appreciate everyone joining us this morning. Of course you’re welcome to call us if there’s any follow up questions.

Operator

This concludes today’s conference. You may now disconnect.

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