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SWS Group, Inc. (NYSE:SWS)

F4Q2010 Earnings Call Transcript

August 31, 2010 10:00 am ET

Executives

Kathy Kennedy – Corporate Staff

Jim Ross – CEO

John Holt – President and CEO, Southwest Securities, FSB

Ken Hanks – CFO

Analysts

Joel Jeffrey – Keefe, Bruyette & Woods

Hugh Miller – Sidoti & Company

Patrick Davitt – Bank of America/Merrill Lynch

Mac Sykes – Gabelli & Company

Chris Luka – Philadelphia Financial

David Knott – Dorset Management

Kathy Kennedy

Good morning everyone and welcome to the SWS Group’s quarterly conference call and webcast. This is Kathy Kennedy of SWS Corporate Staff. We are pleased you could join us today.

The quarterly earnings press release can be found on our Website at swst.com or on the Yahoo! Finance Website under SWS News. Market professionals on our distribution list should have also received the slides for today's call via e-mail. If you would like to be added to our e-mail list to receive press releases or to be notified of 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 swst.com where it will be archived for the next 30 days. During the question-and-answer session, call participants can access the queue to ask questions by pressing star one on their telephone. Those participating via the Internet can ask questions from the link provided on the webcast page or by e-mailing them to questions@swst.com.

This presentation contains forward-looking statements. Viewers are cautioned that any forward-looking statements, including those predicting or forecasting future events or results, which depend on future events for their accuracy, embody projections or assumptions, or 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 in securities, volatility of securities prices and interest rates, liquidity and capital and credit market, availability of lines of credit, customer margin loan activity, creditworthiness of our correspondents and customers, demand for housing, general economic conditions, especially in Texas and New Mexico, changes in the commercial lending and regulatory environment, and other factors discussed in our annual report on Form 10-K and in our other reports filed with and available from the Securities and Exchange Commission.

At this point, it is a pleasure to introduce Mr. Jim Ross, Chief Executive Officer of SWS. Jim?

Jim Ross

Thanks Kathy and good morning everyone. First, let me introduce additional participants this morning. Mr. Ken Hanks, CFO of SWS Group; and Mr. John Holt, President and CEO of Southwest Securities, FSB. This morning, I will touch on some important topics for SWS Group since our last earnings call. John Holt will provide an update on activities at the Bank, then Ken will provide a detailed review of the numbers for the quarter and the fiscal year. I will finish up with a discussion of our business model and strategic direction, and finally we will open it up for questions. Questions are star one on the telephone, and questions@swst.com.

If you have been following our recent press releases, it is clear we have been going through a period of change in SWS Group. Today, I would like to touch on what has changed as well as what remains the same at SWS.

I am going to talk about our business model, the regulatory environment, what we are doing at the banks and the approach we are taking to fill the CEO position. The recent changes in management at SWS Group have not changed our basic broker bank business model. We continue to believe that the ability provides liquidity to our Bank through low-cost deposits from our brokerage company gives us a very attractive platform. 55 basis points cost of funds is hard to beat. We are still committed to organic growth at the brokerage business by recruiting both retail and institutional businesses.

While the environment for recruiting is not as robust as year ago, we are still finding opportunities to hire quality sales professionals in all of our channels. And while the long-term focus on growth at the Bank has not changed, the current economic environment requires that the Bank focus in short term for credit quality issues. John will discuss this in more detail a little later in the call.

The passage of the Dodd-Frank Act has finalized some of the regulatory uncertainty growth in the Bank side. Our regulatory or our primary regulator will transition from the OTS to the OTC and our holding company will be regulated by the Federal Reserve. We are taking steps at the Bank in the holding company levels to be prepared for these changes. The holding company will be subject to more specific rules and is currently the case in the Bank and the Bank will be developing relationships with a new set of regulators. We believe we will be ready for this transaction, this transition.

On the brokerage side of the business, the SEC and others have a lot of studies to perform, and rule-making to do before we know the specifics of the changes for the brokerage business. Of course, we are monitoring these changes as they develop, and believe we will be able to respond in a timely manner. We have made a lot of changes at the Bank from the last quarter of fiscal 2010 to focus on credit quality and regulatory issues. We have hired staff and special assets, credit and portfolio management discipline to reduce our exposure to real estate and to deal with re-possessed assets in a timely manner. John and the team at the Bank are making progress on items highlighted in the informal agreement with the OTS in moving the Bank to a lower-risk profile.

These changes will result in a repositioning of the balance sheet. We expect to reduce loans primarily in the commercial real estate and land areas and use the additional liquidity to invest in conservative fixed income products. This will provide a more liquid financial position, so that we are ready to take advantage of growth opportunities in the long term. The company has already begun the process of finding the next CEO. We are interviewing search firms and expect to move quickly on this process. We will be looking at both internal and external candidates to find the right fit for this leadership role. Because we have a deep management team with a long history with companies, we expect minimal disruptions for our business during the search period.

And now, I would like to turn it over to John Holt who will provide a more detailed update on the banks.

John Holt

Thanks Jim. I will provide our listeners with an update on the Bank with an emphasis on the regulatory and economic environment. The Dodd-Frank Act establishes the Consumer Financial Protection Bureau, an independent organization within the Federal Reserve dedicated to promulgating and enforcing consumer protection laws. This portion of the Act should not put undue burden on the Bank as we are primarily focused on commercial banks. SWS Group Inc. has been a thrift holding company, but will become a bank holding company regulated by the Federal Reserve.

Additionally the Act abolished the OTS and our Bank would be regulated by the Office of the Comptroller of the Currency and it is anticipated that core and risk-based capital requirements will increase industry-wide. The Bank has entered into an informal agreement with the OTS and as a result minimum core and risk-based capital levels of 8% and 12% are to be maintained, which we had already targeted and maintained for the past several quarters.

In addition, the Bank has established plans to reduce classified assets and commercial real estate concentration. In accordance with the informal agreement and our plans to reposition the balance sheet, we have limited real estate lending and focused our efforts on commercial and industrial lending. We will be further reducing the Bank’s classified assets as well as concentration in real estate, construction and lot and land development exposures.

Again, the Bank maintained 8% and 12% total risk-based capital requirements during the quarter. Also, we are targeting $15 million in the quarter in REO sales. Having recently hired a Director of Special Assets and further increasing our staffing level in this department with experienced senior level officers, we are also evaluating bulk sale opportunities to include real estate loans, non-performing and underperforming occurring loans.

We have continued to reduce our exposure to non-owner occupied commercial real estate and as well as construction and development lending as we reposition the balance sheet. Excess liquidity from these activities will be invested as Jim mentioned into shorter-term high quality securities that have a good risk-adjusted return. We will continue our focus on commercial industrial lending to small and middle market companies in the regional markets we serve.

Average gross loans increased for the quarter by $126 million and were primarily driven by increased spending volume and balances in our mortgage purchase department. Deposits provided by brokerage increased to $1.27 billion during the year. This is consistent with the broker bank model as these deposits account for 86% of the Bank’s average total deposit base.

Non-performing assets are elevated at 5.26% to total assets, which are concentrated in commercial real estate, lot and land development and residential homes primarily located in the North Texas marketplace. The Bank has continued to focus on quick conversion of non-performing loans into real estate loans with the intent of spot disposition thereafter. We are currently evaluating various additional asset disposition strategies to complement the Bank’s organic approach to reducing non-performing assets at the Bank.

REO for the quarter ended at nearly $45 million, representing 48% of total non-performing assets. During the year, the Bank sold in excess of $31 million of REO properties and foreclosed on approximately $56 million, further indicating the primary strategy of converting non-earning assets to marketable collateral. The special assets department has added a senior level commercial real estate sales officer to enhance our disposition activities already in place.

Average loan growth was primarily attributable to growth in mortgage purchase as home purchase activity drove funding volume throughout the quarter. Construction balances, both commercial and residential, declined considerably during the quarter, as the Bank has restricted lending in these areas in alignment with repositioning of the balance sheet. We expect to continue to see balances decline in these periods as well as in the commercial real estate and residential lineup.

Our primary area of focus, commercial industrial lending has grown over 39% for the year. Net charge-offs for the linked quarter were down, however remained elevated at $6 million. Due to provisioning of $10.7 million Bank’s allowance grew to $35 million, representing just under 3% of loans held for investment. Both the yield on earning assets and the Bank’s net interest margins grew during the quarter as a result of high average balances in our mortgage purchase area. The focus of the Bank will be centered on improving fed quality metrics where reduction in classified assets in commercial real estate concentrations while repositioning the balance sheet to include higher quality investment securities and commercial and industrial loans. We remain active in the marketplace and are seeing opportunities to expand our presence in regional commercial banks.

I look forward to updating you all on the progress in the coming quarters. With that, I will turn it over to Ken Hanks.

Ken Hanks

Thanks John. Good morning everyone. This morning, I will spend a few moments discussing our overall financial results for both the quarter and the year, followed by more detailed discussion of our segment results, then discuss our consolidated income statement and conclude with some of what we think are key businesses.

Revenues were $101 million in the quarter compared to $122 million in the fourth quarter of last year. Net revenues were down $9.7 million to $89.3 million in the fourth quarter versus $99 million last year. While we were close to breakeven for the quarter, we recorded a net loss totaling $305,000 or $0.01 per share. Book value was $11.85 at the end of the year. Fiscal year end net revenues were $367 million versus $382 million in fiscal 2009. We posted an annual net loss of $2.9 million or $0.10 per share versus $0.86 profit last year. Even with the quarterly and annual losses, it is important to note that the brokerage segment were profitable for the quarter in a challenging environment.

Our first segment to talk about clearing. Clearing segment revenue was down from last year’s fourth quarter while legal expenses related to the correspondent trading loss we experienced in the first quarter reduced profitability from $985,000 in last year’s fourth quarter to $592,000 in the fourth quarter of fiscal 2010. Year-to-date results were also negatively impacted by the correspondent trading loss in the reported quarter of the year. Our topline in this business looks good, and we are making progress rolling out new products to benefit this segment. In the fourth quarter, we began the rollout of our new client-facing Website. So far, response from clearing customers have been good.

The results for the retail segment show a year-over-year and quarter-over-quarter return to profitability. Pretax for the fourth quarter of $891,000 is a dramatic improvement over the $2.1 million loss last year. For the full fiscal year, pretax profit was 219 [ph] versus a $2.4 million loss last year. Retail was also up a substantial $1.9 million over the third quarter in pretax results. Recruiting earlier in the year and cost realignment on the West Coast contributed to the improved results.

Institutional results while down versus the prior-year period were still robust and showed a $1.9 million pretax improvement from the third fiscal quarter. Taxable fixed income has settled down from the unusually widespread of last year and strategic new hires have allowed us to maintain a stronger profit base in the current environment. Municipal new issue volumes were good in Texas in the fourth quarter, contributing to the results for this segment. Stock loan spreads were depressed in the quarter but have recovered somewhat since the end of fiscal 2010. Pretax profits were $11.4 million in the quarter in the institutional segment versus $17.3 million last year.

The full-year profits came in at $53.2 million, down from the $59.7 million of fiscal 2009. We have talked a lot about the Bank already and this slide depicts the financial impact of the environment we have been talking about. The Bank’s net revenue remains strong for the fourth quarter at $20.6 million, but the provision for loan loss and expenses related to owned real estate led to a fourth quarter pretax loss of $3.6 million versus a $4.7 million profit in last year’s fourth quarter. Total provision and expenses related to real estate owned were $14.4 million for the quarter. The outsized loan loss provision in the third quarter was the primary driver of the annual pretax loss of $17.8 million versus a $11.3 million profit last year.

Turning to our income statement caption, operating revenues were down 15% in the fourth quarter and were down 2.8% for the year. Net revenue from clearing was about flat with the fourth quarter of last year and down about $1 million year-over-year. In the quarter, we processed 611,000 trades, down from 781,000 the same quarter a year ago. Day trading tickets were the primary driver of the decline in tickets. Annual ticket volumes also reflected a decline in day trading tickets as well, with 2.3 million tickets processed in fiscal 2010 versus 9.4 million in fiscal 2009.

On the other hand, revenue per ticket was up for fiscal 2010 to $4.46 versus $1.23 in 2009. Commissions were down $6.1 million or 14% in the quarter and were down 12% year-over-year. As expected, the record results we experienced last year in taxable fixed income have leveled off, causing most of the decline in commissions. Investment banking and advisory fees were up 12% in the quarter and were about flat for the full year. The increase for the quarter was driven primarily by municipal transactions, with a little help from managed account fees and taxable fixed income transactions. These increases helped to offset substantially lower revenue sharing from our money market funds.

Net gains on principal transactions, which are derived principally from trading in fixed-income securities, were down $3.6 million or 28% in the fourth quarter as compared to the fourth quarter last year. Increased trading profits in municipal were not enough to offset the decline in trading gains for the taxable fixed income area. For the full year, net gains were up $6.5 million on stronger results from trading municipal.

Other revenue is down $2 million in the fourth quarter, primarily driven by losses on REO properties and reduced valuation of our deferred compensation assessment. For the full year, other revenue is up $8.9 million due to increased fees from the sale of insurance products in our retail segment, an increase in the value of the deferred compensation plan assets, and a gain in the value of our venture capital funds. The deferred compensation plan assets gain is effectively offset by additional compensation expenses in the expense section of the financial statements.

Net interest revenue was up 4.1% in the quarter, but was down 6.5% for the full fiscal year. For the fourth quarter, increases in the Bank net interest revenues were enough to cover the declining net interest revenue at the brokerage business, as the low rate environment continues to impact spreads in the brokerage business. For the full year, the Bank posted a 17% increase in net interest, but the brokerage business showed a 42% decline, primarily from reduced spreads and cash flow. Average margin balances have continued to grow and are up $20 million over the third quarter and up 47% over balances at the end of fiscal 2009.

Stock loan balances have held steady throughout the year. Average credit balances are down versus last year as we increased the limit for the Bank’s suite products to reflect the additional FDIC insurance now available and additional customer funds moved to the Bank insurance products. Operating expenses were down in the fourth quarter versus same quarter last year, primarily from reduced compensation costs, but also from concentrated efforts to hold the loan on discretionary spending. From this slide, you can see the significant impact the increase in the provision for loan losses has had on our expense structure. The provision for the year was $45.1 million versus $13.3 million in 2009.

This last slide presents some of our key operating statistics. Correspondent account is down by 9 versus the March quarter. However these 9 correspondents were all very small and represented less than $100,000 of revenue. Headcount of 1,142 shows a slight reduction from both comparable periods as we have streamlined retail operations on the West Coast and selectively reduced staff at the Bank. While recruiting is normally lighter in the summer months, we were able to maintain our producer headcount. With that, I will hand the mike back to Jim.

Jim Ross

Thanks Ken. As I mentioned at the first of the call, while we are going through a transition period in some respect, our basic business model and strategic plans are unchanged. The ability of our brokerage business to provide low-cost deposits to the Bank, while at the same time providing a popular investment products for our brokerage customers gives us an attractive platform for both of our primary business units. And that platform coupled with the experienced banking and investment professionals we employed will provide an engine for the future as we look for the end of this tough economic environment.

In closing, we have the strategies and people to achieve our growth objectives. Thanks to you, our employees, who go above and beyond the call of duty to help us execute these strategies. SWS Group has great employees and I am proud to be on that, too. Thank you to our customers. You are the reason we are here and we strive to earn your business every day. And finally, thank you to the shareholders for your confidence and support. And we look forward to sharing our progress with you in the upcoming quarters.

And with that, we will open it up for questions. A reminder, questions are star one on the telephone and questions@swst.com.

Question-and-Answer Session

Operator

(Operator instructions) Thank you. Our first question comes from Joel Jeffrey, KBW.

Joel Jeffrey – Keefe, Bruyette & Woods

Good morning guys.

Jim Ross

Good morning.

Joel Jeffrey – Keefe, Bruyette & Woods

I guess first question. Given sort of what is going on in the Bank and the MOU, is there any concern about your ability to maintain your dividend?

Ken Hanks

Joel, this is Ken. Not at this time, the total dividend is $0.36, it’s a little over $9 million, it’s almost $10 million a year. We don’t see that as a problem right now.

Joel Jeffrey – Keefe, Bruyette & Woods

Okay. And then I am just thinking about sort of the loss provisions going forward. I mean, given the disclosure you guys gave us on the criticized loans, do you see it staying at the $10 million level, or is that something that is going to sort of tick back down to maybe the $5 million to $6 million that we had seen in the past?

Ken Hanks

I think that the big driver in the provision calculation is actual charge-offs, and until the $12 million in charge-offs that we took in the third quarter rolls out of that, another two quarters, actually it will be after the March quarter, I think you are going to continue to see elevated provisions.

Joel Jeffrey – Keefe, Bruyette & Woods

Okay. And then I guess just lastly, given that we are two months into the current quarter, I was just wondering if you guys could give some commentary on how business is shaping up for this quarter?

Ken Hanks

At this time, no. We can’t comment on that.

Joel Jeffrey – Keefe, Bruyette & Woods

Okay. Thanks for taking the questions.

Operator

Thank you. Hugh Miller, Sidoti & Company.

Hugh Miller – Sidoti & Company

Hi there. I guess going back to the Bank, I was wondering if you could maybe just provide a little bit more color on the conversations that you did have post the quarter with the OTS. I guess it seems as though there was a rise in non-performers relative to when you guys had filed the call report. I just kind of wanted to get a sense of that and also, given the new strategy of disposing of certain assets, how should we be thinking about the charge-offs levels given where they have been in this past quarter?

John Holt

Hugh, this is John Holt. Couple of things, talking about the strategies on both sales, we would obviously have to calculate what kind of discount there would be in the marketplace if we did that. Obviously, that would get the disposition of them much quicker than if we take the one-on-one approach on a case-by-case basis on the disposition of each assets.

Hugh Miller – Sidoti & Company

I guess certainly I can understand that. I guess you guys had mentioned that there – I have it written down, the target goal for disposition. So I guess assuming that the rate of disposition is kind of somewhat in line with that kind of target, I guess can you comment then on your expectation for charge-offs if that were to happen?

John Holt

I think it would be similar to what we are – we are not seeing anything dramatically different, so they would be similar to previous quarters. That number was it.

Hugh Miller – Sidoti & Company

So, yes, about $6 million? Because obviously I think in the quarter before, it was closer to $12 million. So, somewhere in the current quarter's rate would be kind of what you might anticipate?

John Holt

Yes, of course, Hugh, you head back properties and you get current evaluation and it’s really depending on how the evaluation has come back when you have a borrower that defaults on the loan.

Hugh Miller – Sidoti & Company

Okay. I certainly understand that. I am just trying to gauge a sense of where your expectations are with where we are right now in the cycle going forward. I guess one other question I had about the Bank. Given that you have talked a little bit here about your expectation for reducing exposure to real estate, I was just I guess maybe wondering if you could give a little bit of color on – I guess on a sequential basis there seemed to have been an increase in both commercial real estate, up about I think 12%; and then an increase in the overall loan portfolio at 9%. So, I guess the shift in strategy and obviously you guys are sending the message that we should see a contraction in the loan portfolio going forward. I was just wondering if you could give a little color on that and then also on the sequential increase in the earning assets, and therefore the NIM, and what we should be looking for there as well.

John Holt

All right, Hugh. A couple of things, one of the things you see in the commercial real estate increase are going to be offset by the reduction in the commercial construction. You will notice that’s down about 52% and so what ended up happening here is a lot of those loans are going to mini firms that came out of there. The anticipation is that we are going to restrict non-owner occupied, both construction as well as permanent mortgages. So, anticipate seeing that go down. You can look at the construction, whether that be residential or construction on both quarterly as well as annual basis, and those have gone down significantly. So, we are targeting to be under 300% and commercial real estate loans to our capital plus reserves.

Hugh Miller – Sidoti & Company

Okay. And I guess a couple of questions on the retail segment. It seems as though in both channels, the PCG and the Independent, there was a sequential contraction in the number of advisors on a net basis. I was wondering if you could maybe give us a sense of how the gross figures kind of stacked up on a quarter-to-quarter basis?

Ken Hanks

Hugh, the gross figures is for the headcount?

Hugh Miller – Sidoti & Company

Yes.

Ken Hanks

I don’t have any specifics in front of me. I would tell you the gross numbers also were pretty flat. You just didn’t have a lot of movement in there off the top of my head. I can get that for you, but I don’t know the exact number.

Hugh Miller – Sidoti & Company

Okay. And then I guess given your recruiting goals for the coming year, how quickly would you say – given where your conversations are going now with advisers that you would anticipate that you would see some type of sequential rise in headcount?

Jim Ross

One of the busier times in recruiting and what’s going to be a big asset success for us in recruiting is going to be going into the next three and four months. You grow into a time now, people are back from the summer, they are back, and they are going to move, but then it will pretty well stop about the middle or last part of November. They will stop moving and then it will pick up again the middle of January. So, it’s very crucial to us to have a very good recruiting season this fall. Primarily, we are looking on the West Coast that we have restructured out there, putting people in new place, in some new roles and very excited about what they are doing. So, we will see. This has been a very start and stop environment for the last year, I know you are aware of. The competition is getting very fierce, and we have seen some new strategies employed. So, it’s going to be a very interesting year for us moving forward.

Hugh Miller – Sidoti & Company

Okay. And do you guys, can you talk about the goals you do have then on the recruiting side for the coming year?

Jim Ross

Yes, we started off this fiscal year with a goal of a net 20-30 [ph]. And when we look at, when we talk about headcount, that’s an average producer of 350,000. That is our target goal for the year. I will be honest with you, we are running about on that goal, pipeline, time of year etcetera, maybe split them a little bit, you get up to 800 [ph].

Hugh Miller – Sidoti & Company

Okay. And was wondering if you could provide a little color too on the – it seems as though the customer assets down about $600 million, but obviously holding in much better than the market there, and given the little bit of contraction in the number of advisers, I was wondering if you could talk at all about whether or not you are seeing any type of uptick in just increase in the number of client accounts and bringing in assets to the company, any color on that?

John Holt

All right. Hugh, we generally, we actually do report out and watch our ACAS [ph] and our accounts open each month quite frankly. And over the last, I can’t remember three months ago, but over the last two months, we have been net up about 3,000 accounts per month mainly by net openings of new accounts versus ACAS. ACAS has been relatively flat. So, it’s net new accounts.

Hugh Miller – Sidoti & Company

Okay. And I guess the last question before I will jump back into queue is, it seems on the retail side that net revenue for adviser all-in on both channels is about, I guess $53,000 in this particular quarter, up about 4% sequentially. And obviously given some of the challenges in the latter part of the quarter, was wondering I guess if you could just talk to us about maybe what you saw from a month-to-month standpoint during the June quarter, and any type of overall color about the operating environment since then would be very helpful?

Ken Hanks

These things you are seeing there, and we do track and we pay a lot of attention to that average productivity number. Clearly, you see the recruiting has stayed kind of flat, the fact that the average recruiting desk in the number of new accounts coming in the assets, that’s a big part of what we are trying to do and what we are able to accomplish right now, both retail and the institution guys are doing the same thing with in their area. I am sorry. Now, the second part of your question again?

Hugh Miller – Sidoti & Company

It’s just I guess since then, since the end of the June quarter, I was wondering if you could just talk about the operating environment on a relative basis. Since the kind of the end of the quarter, are you seeing more engaged retail client, or about the same or any color there?

Ken Hanks

Here we look at – we try to normalize what’s going on in the brokerage side of the business on commissions and trading profits, and with an average daily revenues, and frankly, so far in this quarter, the average daily revenues have been on the brokerage side of the business very similar to the June quarter.

Hugh Miller – Sidoti & Company

Okay, thank you very much.

Ken Hanks

Thank you.

Operator

Patrick Davitt, Bank of America/Merrill Lynch.

Ken Hanks

Good morning Patrick.

Patrick Davitt – Bank of America/Merrill Lynch

Hi guys. In regards to the Memo of Understanding with the OTS, do you feel like I guess the changes in origination parameters are much different than the changes you were already making?

John Holt

Patrick, this is John Holt, and the answer is no. We have already reduced the exposure in the underwriting both on the residential construction. If you look on the year-over-year reduction in residential construction, it was 39%, from $149 million to $90 million. The commercial construction was down 52%. So, a lot of the areas construction lot and land etcetera, we had already restricted. And so, I think that it more closely aligns with our operating environment what we were already beginning with.

Patrick Davitt – Bank of America/Merrill Lynch

And broadly, you are just focusing on reducing the non-owner occupied buckets?

Ken Hanks

Patrick, I think the biggest difference between what we were doing and what we are going to be required to do in terms of our concentration in commercial real estate is that we now have a number we are shooting to get at, which is what we time our capital. So, we are looking to take that commercial real estate and construction numbers down to under $450 million from where they currently are.

Patrick Davitt – Bank of America/Merrill Lynch

And what’s the timeline for that?

Ken Hanks

We would like to have that done by September of ’11.

Patrick Davitt – Bank of America/Merrill Lynch

Okay. You spoke to, I guess, the kind of higher capital ratios involved with this agreement with the OTS. Do you expect the OCC will require higher ratios than that?

John Holt

This is John. I don’t know what they will do in the discussion points on the Dodd-Frank Bill or Act at this point and I don’t necessarily know that require higher, we have been operating under the 12% and 8% for several quarters now.

Patrick Davitt – Bank of America/Merrill Lynch

And could you update us on the ability for the Bank to use excess capital from the parent to keep that ratio above there should you need additional capital, as opposed to going to the open market?

Ken Hanks

There‘s actually two things that are going on, Patrick. One, the Bank can have a pretty substantial impact on its capital anyway, especially if it’s risk-based capital based on its activity. And one of the things that can do is it can reduce some of its lending that is held of sale, which is the mortgage purchase plan which they have done, which drives up risk-based capital. So, I would tell you that subsequent to quarter again, they have done that, and risk-based capital has gone up substantially from where it was in the K.

Patrick Davitt – Bank of America/Merrill Lynch

Right.

Ken Hanks

So, that’s kind of one step. The other would be obviously coming from the parent. The parent still has over $7.5 million that had got originally in the offering last year that it still has at the parent level, and the broker deal, I think you can see in the K, has somewhere around $120 million, $420 million, $527 million [ph] of capital. So, we feel like there is essentially significant capital there that if we needed, we can move and still maintain our $100 million of capital target for the broker dealer.

Patrick Davitt – Bank of America/Merrill Lynch

Okay. And then lastly, could you kind of update us on what the loss experience has been on your more recent REO sales?

Ken Hanks

They have been very similar to what they have been in past quarters. We are not taking a dramatic increase in charges. Again, the idea of a bulk sale or another strategy would allow us to move it up quicker.

Patrick Davitt – Bank of America/Merrill Lynch

Okay, okay. Great. Thanks a lot guys.

Ken Hanks

Thank you.

Operator

Mac Sykes, Gabelli & Company.

Ken Hanks

Good morning.

Mac Sykes – Gabelli & Company

Hi, good morning. I was just looking at the CRE portfolio, about $100 million is maturing in the next 12 months. I guess, how do you think about rollover risk there? And then maybe you could provide some color on what the aggregate LTV is for those loans?

Jim Ross

A couple of things. The rollover is depending upon the type of property that it is. If its owner occupies, they need those facilities to operate their core operating businesses, and if it’s not owner-occupied, then certainly you would be looking at where they are in terms of their debt service coverage ratios, in terms of renewing it what we try to do when those come up for maturity is bring them back in line to the degree you can to where you originally made the loan. What our typical lending would be, would be 80% or less in the older vintages in terms of loan to value.

Mac Sykes – Gabelli & Company

Great. I guess at this point, would it be wrong to assume that there could be some client attrition due to perceptions about capital requirements at the Bank? And then secondly, are you getting any pushback from trading counterparties, perhaps related to some of those concerns?

Jim Ross

As far as it relates to customers, the commercial real estate customers have nowhere to go. I think we are the only ones that are focused –

Mac Sykes – Gabelli & Company

No, these would be brokerage clients, with deposits at the Bank, I guess.

John Holt

No, we haven’t seen any issues there at all as a matter of fact, and no issues from trading partners either.

Mac Sykes – Gabelli & Company

Great, thank you.

Jim Ross

Thank you.

Operator

Chris Luka, Philadelphia Financial.

Chris Luka – Philadelphia Financial

Hi guys. Thanks for taking the questions this morning. I want to go back to one question that Hugh Miller had asked earlier that didn't get answered. The TFR reports were filed a couple of weeks ago. And in there you had non-performing assets of $77.7 million and provisions of $7.7 million, but yesterday, you reported an increase from that number of $16 million on the NPA side and $3 million on the provision side. What is the difference there?

John Holt

Yes, this is John Holt. The addition is that we were still within the scope of our audit. We have taken on addition third party as well as internal long reviews, and we as a company decided that there was one that should be classified –

Ken Hanks

Can I help really?

John Holt

Yes.

Ken Hanks

It’s currently an accounting question, so I am going to help out with that if you don’t mind, Chris. Basically, prior to year end after the environment that we have seen in the third quarter of the year, we became concerned that we wanted to be sure that we had a good 10-K, it was properly reflecting the loan portfolio, and we have seen appraisals coming in for our own – on our own that did not necessarily jibe with the loan reviews that we had going on previously. And so we decided to get more, I guess visibility into the loan portfolio and the classification business. One thing that’s happened at the Bank over the last four or five years is that it has grown substantially, and we have brought loan officers in from lots of different banks, credit officers in, and while we have our own risk rating system, they all are coming from different environments. So, the first thing we did or one of the first things we did was we trained everybody, so everybody would have a common understanding of how we want them to look at loans to determine where they go in our risk rates. And that task actually took a lot longer than we thought. So, the TFR had to be firing at the end of July prior to our finishing that task. Yes, we still wanted our K to be right, and we probably did finish that task in August and that did create about $3 million difference in our charge-offs that did change the classified assets in terms of dollars. And so, we reflected that in our K and filed an amended TFR to make the K and the TFR consistent.

Chris Luka – Philadelphia Financial

Okay. And then the other question I had is – you talked about the OTS requiring you to or maybe they didn't require you, but you just decided to hire more people on the credit team to sort of combat this increasing deterioration in credit quality. How much of that is going to negatively affect the efficiency ratio at the Bank?

John Holt

It’s not going to dramatically affect it, but what is happening is some of the loan officers that would have been here as originators will no longer be originating the same levels of loans, I anticipate some of that attrition from not being able to originate the loans will go into cost into the collection of it. So, there shouldn’t be a dramatic change in the efficiency ratio.

Chris Luka – Philadelphia Financial

Okay. Thanks guys.

Operator

David Knott, Dorset Management.

David Knott – Dorset Management

Yes, hi. Could you comment on – if you look back to say 18 months, 24 months ago, what were the lending standards of the Bank? And I would break that into several things. Did you do much or what percentage of your loans were out of market? Number two, how much money did you get down for a mortgage, for a personal mortgage? And three, did you get personal guarantees on your commercial loans?

John Holt

Okay, this is John Holt.

David Knott – Dorset Management

Hi.

John Holt

Very little is done out of market. It’s primarily in the North Texas area as the portfolio. We didn’t do a whole lot of first mortgages. We actually took and we disposed off our existing mortgage origination group. So, you have very little mortgages, but when we did take a mortgage owner on our books versus selling it out in the secondary market, it would typically have 20% to 30% down, and was probably a jumbo mortgage.

David Knott – Dorset Management

Okay. What about personal guarantees on the commercial?

John Holt

The majority of all of the commercial loans had personal guarantees paid.

David Knott – Dorset Management

Okay. Great, thank you.

John Holt

Thank you.

Operator

Hugh Miller, Sidoti & Company.

John Holt

Hi Hugh.

Hugh Miller – Sidoti & Company

Hi, there. Just a question, follow-up, maybe looking at the institutional segment just a bit. I guess on a sequential basis, obviously the operating environment is much more challenging on a year-over-year basis. But just wanted to get a little bit of color on the sequential improvement that you did see within the taxable fixed income commission side? Obviously I think you guys had mentioned that we saw a rise in investment banking fees. I am assuming that is driven more by the muni environment in Texas for the new issuance, and then also maybe a small increase in principal gains. Just wanted to get some color on the environment relative to September quarter, whether or not you guys are seeing an uptick in competition from some of the larger competitors out there, and any risk that you guys potentially could see from peers trying to maybe poach some of the talent that you have at the company, even though I guess on a sequential basis, you were able to add one fixed income rep during the quarter, but just any color on that would be great?

Jim Ross

If I understand your question correctly, I am going to answer that. It has always been very competitive. It continues to be very competitive and by that, I mean to address, do we have competitors trying to poach our talent? All the time. Are we trying to poach their talent? All the time. So, I mean, it’s a very competitive environment out there with people trying to get talent onboard. And I would say, those guys, Dan Leland and Richard and those groups are doing a great job. We are holding our own if not a little bit better. Ken raises his hand here to jump in.

Ken Hanks

Hugh, in addition to that, while we only track the people that we keep consistent with pace is showing the sales people that are in the organization in the fixed income area. But in my comments when I was alluding to the fact that we hired other professionals, our expanded our trading desk, both in the muni area and the taxable area to encompass broader products and actually to penetrate the market more. So, actually conversely to shrinking, they are actually growing at this point of time.

Hugh Miller – Sidoti & Company

Okay. Maybe just a follow-up there. I guess we saw some of your peers that kind of maybe gave back some of the market share that they had enjoyed over the last year or so. And just want to get a sense from your comfort level going forward with maybe some of the new hires that you have done, do you anticipate that we should see growth going forward within the institutional segment, or do you anticipate that you will be giving back some share to maybe renewed effort from some of the larger peers playing catch-up?

John Holt

I don’t see us giving back share. I think in fact, we gained a lot of momentum in some of areas from where we grew a year and 18 months ago. Now, granted in taxable, it was huge, very strong market that now has normalized. But I don’t see as given that market share and in fact I would like to set here things that we are going to continue to grow and gain market share and institutional here is a very broad term. When you start breaking that apart, stock loans, portfolio trading, corporate finance, all those things, they have got some individual dynamics such as interest rates, etcetera as to what is going to happen there. But to answer your question overall, no, I don’t see us turning around and giving back. And the fact, some of the larger firms are going to get more competitive. That’s fine. We see us always being pretty much competitive.

Hugh Miller – Sidoti & Company

Okay. Thank you very much.

Operator

Mac Sykes, Gabelli & Company.

John Holt

Good morning.

Mac Sykes – Gabelli & Company

Hi, just a quick follow-up. Could you just remind us about the movement of capital, say from the brokerage firm to the Bank? Do you or is it a seamless process? Do you need to get regulatory approval for that? Does it take a few months? I mean, what is the process that would take place if you were to move capital from one to the other?

Ken Hanks

To move the capital from the parent to any sub is really easy. I mean, it’s basically doing the internal corporate resolutions that we have to do as a company. So, it’s a very short term, very quick. To take money out of one of the subs that are both regulated, we are governed by the rules, but I guess the most relevant case was if we decided to take like $10 million out of the broker dealer, the question is, is that something we can do immediately, and the answer is yes. Up to a pretty substantial number, we have 25% of our net capital, tentative net capital can be taken out of broker dealer with just an information basically telling the regulators what we are doing is if you go more than that, you would have to have permission.

Mac Sykes – Gabelli & Company

Okay. So just to get the exact number, I think you said you had excess capital of about $150 million at the brokerage?

Ken Hanks

$127 million –

Mac Sykes – Gabelli & Company

So, how much of that would be available to immediately fund the Bank, I guess?

Ken Hanks

About $30 million.

Mac Sykes – Gabelli & Company

Okay, thank you.

Operator

Our last question comes from Patrick Davitt, Bank of America/Merrill Lynch.

Ken Hanks

Hi Patrick.

Patrick Davitt – Bank of America/Merrill Lynch

Hi, I just wanted to check on in terms of the provision in reserving, how much of that is being driven by actual credit quality versus just deterioration in the collateral?

Ken Hanks

It’s going to be a combination. The model takes into consideration historical losses. The biggest factor is the look-back period on the historical losses, and so that was part of its last quarter. We replaced a three-year look-back to one year and that had the most substantial impact both that quarter, but also this quarter also.

Patrick Davitt – Bank of America/Merrill Lynch

Okay, all right. Thank you.

Ken Hanks

Patrick, I am not sure I really completely understand your question. While going back to something I said earlier and that is the charge-offs are one of the key to the provision and I would say that of the $6 million in charge-offs we had in this quarter, there was a couple of substantial ones that are loans where we are taking a charge for a revaluation of collateral. And so, –

Patrick Davitt – Bank of America/Merrill Lynch

But the loan is still performing?

Ken Hanks

But the loan is still there, right. Exactly.

Patrick Davitt – Bank of America/Merrill Lynch

Yes, okay. Do you have any or can you give us an idea of how much that, what that number is?

Ken Hanks

Well, I only know the one – I just only know the one loan –

Patrick Davitt – Bank of America/Merrill Lynch

Okay.

Ken Hanks

Other than that, yes.

Patrick Davitt – Bank of America/Merrill Lynch

Okay. Thanks.

Jim Ross

Thank you.

Ken Hanks

We have one question from the e-mail, which says, you lost $0.10 per share, yet book value was down $0.60. Could you please explain that? Absolutely, we can explain that. Dividends paid last year was $0.36. We had a $0.10 loss. The dilution because of the offering in December was around $0.24, and we had other items that were around $0.06 that had to do with restricted stocks that was forfeited options, I would call it miscellaneous noise. So, the actual net difference was $0.63.

Jim Ross

Okay, at this time, are there any other questions. It is star one on the telephone, questions@swst.com. It looks like we have no more questions. With that, we would like to thank everybody for attending and hope to see you again next quarter.

Operator

This concludes today’s conference call. Thank you for your participation. All parties may disconnect at this time.

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