SWS Group CEO Discuses Q3 2010 Results - Earnings Call Transcript

Nov. 3.10 | About: SWS Group, (SWS)

SWS Group Inc. (NYSE:SWS)

Q3 2010 Earnings Call

November 03, 2010 10:00 am ET

Executives

Kathy Kennedy - Corporate Staff

Jim Ross - President and CEO

John Holt. - Chairman, President and CEO, Southwest Securities, FSB

Stacy Hodges - Interim CFO & Treasurer

Analysts

Joel Jeffrey - Keefe, Bruyette & Woods

Hugh Miller - Sidoti & Co

Mac Sykes - Gabelli & Company

Kathy Kennedy

Good morning, everyone and welcome to the SWS Group quarterly conference call and webcast. This is Kathy Kennedy of the 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 email. If you would like to be added to our email 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, the call participants can access the queue to ask questions by pressing *1 on their telephone. Those participating via the internet can ask questions from the link provided on the webcast page or by emailing them to questions@swst.com.

This presentation contains forward-looking statements. Readers are cautioned that any forward-looking statements, including those predicting or forecasting future events or results, which depend on future events for their accuracy and body projections or assumptions or express the intent, belief or current expectations of the Company or management, are not guarantees of future performance and involve risk 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 security prices and interest rates, liquidity in capital and credit markets, availability of lines of credit, customer margin loan activity, credit worthiness of our correspondents and customers, the ability of the bank's borrowers to meet their contractual obligations, the value of the collateral securing the bank loans, demand for housing, general economic conditions, especially in Texas and New Mexico, changes in the commercial lending and regulatory environment, the ability to meet regulatory capital requirements and other factors discussed in our annual reports on Form 10-K and in our other reports filed with and available from the Securities and Exchange Commission.

This conference also contains references to non-GAAP financial information, which is being presented to provide additional information regarding the Company's operations and should not be used in place of GAAP measures. The Company's press release and today's slides include a reconciliation of these non-GAAP measures with the Company's GAAP results.

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

Jim Ross

Thank you, Kathy. Good morning, everyone. Let me take this opportunity to introduce our other participants. We have with us this morning Ms. Stacy Hodges, CFO of SWS Group and Mr. John Holt, CEO of Southwest Securities FSB, our bank.

Our agenda for this morning, first, 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. Stacy Hodges will follow up and provide a detailed review of the numbers for the quarter and I will finish with a discussion of our strategic direction. After that, we will open it up for questions. As Kathy said earlier, star one for those of you on the phone, that is questions@swst.com for people participating on the internet.

This morning, I am going to give you an update on SWS Group. SWS Group is a diverse group of businesses composed of a great brokerage operation, a bank, one that is working to become stronger and more diversified and a holding company with no debt and access to capital markets. This call will focus on what is going well at SWS Group, as well as what is more challenging.

To start, what is going well is the brokerage side of the business. We believe we have a significant opportunity in this business and we are well-positioned in our marketplace. With the challenges experienced by the national firms in the current economic cycle, regional firms have benefited from a good recruiting environment and a chance to enter new business lines. All of our brokerage operations, but particularly the retail and institutional segments, are taking advantage of this opportunity.

The combined scope of our brokerage operations is approximately 78% of first-quarter net revenues. We are pleased to report that each of these segments was profitable in the September quarter. These business lines are operating very well despite the interest rate environment and sluggish economic growth.

Southwest Securities, our primary brokerage subsidiary, ended the quarter with a strong net capital position, over $105 million. It is our plan to operate Southwest Securities at a minimum of $100 million net capital level. The bank, at 22% of net revenue, is facing some challenges on both the regulatory and economic front. Bank management is focused on reducing classified assets, repositioning the balance sheet while maintaining excess capital liquidity.

The Retail segment had a nice quarter, especially considering the summer months are generally a slower time in this segment. The key to growth in this business is the recruiting of representatives that will be a good fit for Southwest Securities. Sometimes our recruiting opportunities lead us to evaluate and then move into new office locations. The December quarter is always a difficult one for recruiting as we look forward, but we are looking forward to starting off a strong new calendar year.

On the Institutional side of the business, we are seeing growth opportunities across those business lines. We are seeing opportunities in this segment as the national firms shed businesses that no longer fit their business model, but are a good fit for regional players. We also have opportunities in this segment to increase the size and depth of our client relationships.

Clearing has been a great business for the firm. It is one that absorbs a lot of fixed costs, contributes to our ability to be competitive in the retail marketplace. We are focused on building scale in this business. We are also analyzing this segment to make sure we have defined the potential clearing markets appropriately.

We own a bank in Texas. It should come as no surprise that financial results from this operation were challenging in the quarter. As Texas was late to the party, the real estate market here is now very challenging and we are playing catch-up in a negative way, but with the markets on the coasts. Because our bank is thrift, we were naturally concentrated in the real estate market and bank management is positively focused on dealing with the results of that concentration today.

First and foremost, we are currently in compliance with the terms of the MOU, memo of understanding, we discussed last quarter. Our capital ratios are above the required minimums and we are making some progress on repositioning the balance sheet.

Our focus in the next few quarters will be dealing with the classified assets in an aggressive manner. John will speak more about our specific strategies later, but it is clearly our biggest challenge over the near term. While the long-term focus on growth at the bank has not changed, the product mix at the bank is likely to be more diversified once we are ready to grow the bank again. This diversity will help us weather uncertain economic times with much less volatility in our earnings.

Net revenues continue to be strong in the first quarter of fiscal 2011 and are in line with last year. Looking at our income numbers eliminating the effect of the loan loss provision produces income numbers also in line with last year. Obviously, we cannot ignore the provision, but the pretax, pre-prevision income of $9.2 million gives some indication of how our businesses are performing outside of the current business issues.

While John will discuss the provision in more detail later in the call, some of the actions we are taking to deal with our classified assets have contributed to the size of the provision in the first quarter. We ended the quarter at a net loss of $0.64 per share and a book value of $11.14 per share.

All of our brokerage segments were profitable for the quarter and generally showed progress from the year-ago quarter. The Retail business was profitable for the second consecutive quarter with net revenues up 12%. Successful recruiting in the independent channel contributed to commission growth in this segment. Our rebranding and reorganization of the West Coast is proceeding as planned. As a final piece to consolidating these operations, we implemented a new compensation plan for our private client group representatives in the quarter. This will streamline operations in the business and simplify recruiting going forward.

While down from last year's first quarter, the Institutional business is still performing very well with a 32% increase in pretax over the June quarter. Taxable fixed income continues to find opportunities to augment their products and produce good results. The municipal business new issue volume was good in the quarter and this unit beat results from both comparable periods. We were pleased to see stock loan spreads improve from the June quarter as this was the first increase in spreads in over a year.

The Clearing segment posted improved results over last year with revenue up 4%. Last year included the $6.3 million correspondent trading loss. The bank results are all the result of credit quality deterioration. We reduced the size of the bank's loan book by $220 million to focus on credit. In addition to the large provision, we recorded about $10 million in expenses associated with REO write-downs, provisions and operating expenses.

That brings us to John Holt who will provide some additional detail regarding the bank's operations. John?

John Holt

Thanks Jim. I would like to provide additional insight into the actions the bank is taking to continue its focus on actively reducing its level of classified assets while repositioning the balance sheet and maintaining excess levels of capital and liquidity.

The bank's primary focus on reducing classified assets includes multiple strategies, which are evaluated on an ongoing basis and include bulk asset dispositions, traditional foreclosure and REO dispositions, short sales, along with other strategic alternatives, such as the transfer of classified assets to a subsidiary of the holding company.

In response to the additional migration and elevated levels of nonperforming and performing classified assets to over $250 million, the bank engaged a consultant to assist with a marketing campaign to auction a pool of classified assets comprised of REO, performing and nonperforming loans. The loans included in the marketing campaign were classified as held-for-sale on the balance sheet, which resulted in an additional charge to reflect the estimated net realizable value for an immediate sale.

Early indications have been favorable as indicative bids are consistent with our targeted prices and we expect closings to occur primarily during the second quarter. Additionally, the bank sold $10.4 million of REO during the quarter with approximately 50% of the sold assets representing single-family homes as the residential REO have been marketable with less holding time relative to the larger balanced commercial real estate and land assets, which require a thorough workout and marketing campaigns. In addition, the bank evaluates on an individual asset-by-asset basis the opportunity for short sales when the sponsors have the financial capability to move a classified asset out of the bank within an appropriate time period.

Although this is not a primary strategy for the disposition of classified assets, the bank will continue to negotiate with qualified sponsors with identified capacity to execute a short sale transaction. Further, the bank is evaluating other strategic alternatives for the disposition of classified assets, which might include the formation of a subsidiary at the holding company level to transfer a pool of classified assets, which primarily have successful characteristics of full repayment, albeit over a longer collection period. The unique structure and capitalization of the firm offers the flexibility to evaluate various strategic alternatives to reducing classified assets at the bank.

The other strategic priority at the bank is focused on repositioning the balance sheet by reducing exposure to certain product types while increasing liquidity and maintaining excess capital. In the slides to come, you will see the bank's progress in reducing its exposure to commercial real estate, land and residential construction during the quarter.

Additionally, the bank has targeted a range of outstanding loan balances for its mortgage purchase department, which is consistent with the balances at quarter-end. By reducing exposure to certain loan types, as well as targeting a lower level of outstanding loan balances and mortgage purchase, the bank has increased its liquidity and risk-based capital levels.

Also, the unique funding model between the brokerage and the bank allows for a fluid sweep of deposits. The bank is evaluating the benefits of implementing a deposit reduction strategy to sweep out excess liquidity, which will further increase the core capital ratio.

We are focused on navigating through the difficulties with our asset quality and are implementing strategies consistent with the goals of reducing classified assets while repositioning the balance sheet and maintaining excess capital and liquidity.

The allowance build of approximately $10.2 million was attributable to the continued migration and growth of classified assets, along with the application of a distressed historical loss factor applied to allowance methodology, which increased the allowance to over 4% of loans held for investment.

The bank's net interest margin at 4.65% remained very strong despite the increased liquidity, which is held in low yielding, short-term securities and exhibits the core earnings power of the strategic relationship between the brokerage and the bank. This slide shows the major balance sheet relationships and highlights the strategic advantage in relationship the bank has with the broker-dealer as approximately 87% of the bank's deposits are provided by the brokerage clients through the bank insured deposit product.

SWS contributed $23 million of capital to the bank during the quarter, which helped facilitate the held-for-sale assets. Our core deposit position remains strong and provides an efficient funding source for the bank and a competitive FDIC-insured cash product for our brokerage clients.

The growth in nonperforming assets for the quarter of $33 million was primarily attributable to legacy assets, which were concentrated in a large condo project located in the North Texas area, along with continued deterioration in real estate land and commercial real estate. The increased staffing and allocated resources to the special assets department is working diligently to resolve, on an asset-by-asset basis, these loans and assets. The larger balance commercial real estate and particularly the land and residential lots have experienced longer marketing periods as the real estate market remains a challenging environment.

We have also begun providing an overview of the performing classified loans, which, although performing, have defined weaknesses, which impact the potential performance of the loan. Classified loans require more stringent monitoring and portfolio management requirements, which include the involvement of the special assets department, as well as other lending personnel across the bank.

Going to bank loans by type, we changed this slide this quarter to show the change in ending balances instead of average balances to reflect the bank's focus on repositioning the balance sheet. During the quarter, the bank was able to decrease loans by $220 million, primarily through reductions in mortgage purchase, commercial real estate in both residential construction and land. Also, our origination focus has been on small and middle market businesses and can be seen in both the quarter and annualized growth in this book and speaks for the lending focus going forward.

This slide deals with MOU with the OTS. The bank entered into an informal memorandum of understanding with the OTS in July of 2010. The primary items include maintaining a minimum core capital ratio of 8% and a minimum risk-based capital ratio of 12%, the preparation of a classified asset reduction plan and a loan review from a third-party consulting firm.

In addition, there were certain lending restrictions in the area of commercial real estate, construction and land, which the bank had already curtailed before the agreement. The bank has been operating with an 8% core capital and 12% risk-based capital position for several quarters and as of the September quarter, the bank was in compliance with all capital requirements, as well as other requirements or provisions in the agreement. While you cannot predict with certainty the continued asset quality deterioration and negative earnings could result in a formal enforcement action by the OTS. Overall, the bank's management staff is focused on the reduction in classified assets and returning the bank to profitability.

At this point, I will turn it over to Stacy Hodges, SWS Group Chief Financial Officer.

Stacy Hodges

Thanks John. Good morning everyone. This morning, I will provide some additional detail on the consolidated revenues and expenses of the firm, as well as a review of a few operating metrics. Looking first at revenues, overall, our operating revenues in the quarter were up 12% from the sequential quarter and were down 6.5% from last year. Comparisons to last year are difficult as the September and December quarters of fiscal 2010 were record quarters for the taxable fixed-income unit. The September quarter for fixed income was a good one, just not a record one.

Clearing revenue in the quarter was down from both comparable periods as ticket volumes were off from both June and last year. In the quarter, we processed 567,000 trades, down from 599,000 in the same quarter a year ago. Revenue per ticket was $429 in the first quarter compared to $439 in the first quarter of last year.

Commission revenue was up 3% from the June quarter on higher taxable and municipal commissions. When compared to last year, commissions were down 9%. The decline in taxable fixed income commissions was partially offset by an increase in commissions in our independent contractor business.

Investment banking fees were up compared to both June and September from increased UIT underwriting and from fees from corporate finance transactions. Net gains on principal transactions increased 34% from June due to substantially improved results in the municipal trading area. The 18% decline from last September was driven by taxable fixed income.

Other revenue was impacted by a $1 million gain on the redemption of some municipal securities at the bank, along with a $1.1 million increase in the value of investments in our deferred compensation plan when compared to the June quarter. Increased fees from the sale of insurance products in the Retail segment caused the variance from September of last year. We were pleased to see some recovery in the net interest income in the brokerage business. Stock loan spreads improved over the June quarter by 17 basis points, but were down versus September of last year by 10 basis points.

Looking at our operating expenses, all of the expense categories are in line with or down from the comparable periods except for compensation and other expenses. The change in compensation is related to variable comp and is driven by changes in the related revenue line. The increases in the other category relate to elevated expenses at the bank. We recorded $9.6 million in expenses for REO write-downs, REO maintenance and consulting fees in the quarter. In June, these expenses totaled $3.1 million and in September of last year, they were only $2.2 million.

As we are able to reduce the classified assets on the bank's books, we should be able to realize significant reductions in these related expenses. Other expenses in September of last year also included a $6.3 million clearing loss.

This last slide provides some key metrics for the brokerage business. Client assets are growing with Retail assets at $13.3 billion as of the end of September. Our independent advisor count is up to 313, while productivity is improving in all of retail.

Margin balances are up a modest 2% from June, but are up 31% versus September of last year. Stock loan balances are improving, up 17% from June and 9.2% from September of last year.

I will now turn it back to Jim.

Jim Ross

In closing, as I mentioned at the first of the call, we have a diverse business model that includes a strong broker-dealer with profitable business units run by an experienced management team. The net capital at Southwest Securities remains strong, over $100 million. The level we view as a non-negotiable component of our business model. We have plans in place to continue to grow this profitable business as opportunities arise. Our bank is working hard every day to reduce classified assets, reposition its balance sheet and to maintain excess capital and liquidity for future operations.

These two business units together provide opportunities that are beneficial to both businesses and make us a stronger whole. As I take a look at the map of our current locations, what I hope you see, as we see, is opportunity. The management team, the Board, and personally, I want to tell you there is nowhere I would rather be than Southwest Securities, SWS Group looking at that map.

With that, I want to take the time to thank our shareholders, to thank our employees and to thank the management team. I know that we have challenges ahead of us, but we cannot lose focus on the opportunities. Let us open it up.

Question-and-Answer Session

Operator

Joel Jeffrey, you may ask your question.

Joel Jeffrey - Keefe, Bruyette & Woods

If you could elaborate a little bit more, I know you talked about if credit continues to deteriorate, there is a possibility of a formal enforcement action. What would that exactly mean for the company?

Jim Ross

I am going to turn that over to John. What we are talking about is the MoU that we are under. As to credit quality deteriorating, how that would impact the terms of that MoU, I am going to let John drill down on that.

John Holt

We don't anticipate that there would be any additional restrictions if, in fact, they formalize that, but we can't predict what the regulatory environment would do or what the regulators would do, but we wouldn't anticipate further restrictions.

Joel Jeffrey - Keefe, Bruyette & Woods

You guys said you are well-capitalized at the broker and you said that $100 million is a hard limit. That would sort of imply that you've got about a $5 million excess there. You are also talking about growing the other businesses. Are you able to do that given that you have been downstreaming capital to support the bank in the past and it looks like you are somewhat limited in doing that now?

Jim Ross

You are correct on both points. The broker-dealer is somewhat limited today at downstreaming to the bank capital. Given the fact that that $100 million is the hard deck or that minimum that we are going to maintain, we are not going to be going forward downstreaming from the broker-dealer at current levels of capital. Yes, we can grow the broker-dealer. There is a lot of growth opportunities that don't take more capital.

Joel Jeffrey - Keefe, Bruyette & Woods

Lastly, given the losses, we talked about this in the past. Is there a possibility that you guys are going to need to reduce or eliminate the dividend?

Jim Ross

One of the things that we are looking at going forward is we are evaluating all the tools we have at our disposal to fix this problem in simple terms at the bank and absolutely, the dividend will be on the table at the next board meeting. I can't tell you management's recommendation. It is not formalized and I obviously can't tell you the decision.

Operator

Hugh Miller, you may ask your question.

Hugh Miller - Sidoti & Co

Piggybacking on the last question, obviously dividend cut being a possibility, a capital raise being another possibility for you guys, you mentioned that you have some levers at the bank's disposal to improve the core capital ratio. What about the total capital ratio? Can you just talk about what are some of the possibilities, aside from those other things, the capital raise or dividend cut, in order to improve the total capital ratio at the bank?

John Holt

Hugh, the things that we can do is to reduce the deposits and that would increase your core capital. The reduction of the deposits would be one of the items, as well as reducing the balance sheet overall. We are going to continue to reduce the balance sheet or shrink it, but primarily the area that would create the core capital would be the deposits.

Hugh Miller - Sidoti & Co

Would that adjust though the total risk-based capital ratios and more a measure of the risk-based assets?

John Holt

Yes, but the risk-based capital is not the issue that we would have. The one that we are more concerned about would be the core capital.

Stacy Hodges

Hugh, this is Stacy. We always have the opportunity to reduce that mortgage purchase line if we'd like to create risk-based capital, which is a relatively easy and quick fix if we decide that is the right thing to do.

Hugh Miller - Sidoti & Co

With where things stand right now, I just wanted to get your take, and obviously you may not be sure, at this point, the way you are viewing things, is a sale of the bank a possibility or is that really an unlikely scenario at this point?

Jim Ross

A sale of the bank is an unlikely scenario at this point. We like looking forward. We like what we see coming out of this economic tunnel having been a holding company with a bank and a broker-dealer. We like being there as we go forward. We give John a hard time and we beat on him all the time, but at the end of the day, we really like having a bank. It is going to be a different bank, but we like having a bank.

Hugh Miller - Sidoti & Co

In the Q you guys mentioned that you have roughly $70 million worth of loans that are up for auction and you mentioned a very nice wide spread of potential costs anywhere from zero to 50% losses that you could potentially experience on the sale there. Just wanted to get a sense of maybe if you can narrow that down, maybe provide some color on the process and the loss rates that you have been experiencing in the disposition of assets more recently?

John Holt

What we did is we worked with a third-party consultant and we have both REO as well as performing and nonperforming loans out in the market. We have about a 25% mark on that and we are coming in at our targeted prices. The mark that we made in this past quarter would be adequate.

Hugh Miller - Sidoti & Co

About 25% loss ratios is what you guys were anticipating where you mark things down to and that is where it is coming in at this point?

John Holt

Yes.

Hugh Miller - Sidoti & Co

It looks as though the reserve coverage ratio relative to NPAs did decline slightly. I know that you did reserve build in the quarter. It came down to roughly 36% from 38% last quarter relative to the non-performers. What makes you guys feel comfortable with that current level right now, reserve coverage?

John Holt

As I would look at it, the ALLL or the allowance would cover about 60% of the non-accrual. The other loans are accruing because you have both the nonperforming loans as well as other classified loans. Within the nonperforming loans, we still have loans that are paying as agreed that are performing nonperforming loans.

Hugh Miller - Sidoti & Co

Can you maybe provide a little bit of color on what is going on with those loans as to why they are in nonperforming status even though they may be currently performing?

Jim Ross

You would have defined weakness and the credit could be anything from the appraised value of the property, etc, financial performance.

Hugh Miller - Sidoti & Co

The last question, you guys had mentioned that you've recently made an adjustment to the compensation plan within the brokerage segment. I was wondering if you could just provide a little bit of insight into the adjustment there and the potential influence on production going forward?

Jim Ross

We made an acquisition two years ago last April of ML Stern on the West Coast. The way they did their compensation versus the way we did from a legacy standpoint, the registered representatives got paid basically the same, but the mechanization, etc was different. The guys out there got a deferred bonus within the earnings period and some things and it became very complicated to explain one versus the other.

What we did is we stepped back, looked at this for more than a year and came up with the effective simplified grid to put everybody on the same compensation level. The one thing that changed this is that producers producing less than $300,000 to some degree their payout was reduced and that was by design. $300,000 producers and above, their payout not only stayed the same but in a couple of categories, they got an increase.

We had two objectives here. One was to focus in on that producer below $300,000 and bring to bear the tools to help them grow their book of business, have more relationships and get up to that $300,000 level. The second objective was as we looked at comparable compensation plans across the street; we wanted to hold true to paying a 25% to 40% premium at production level to the other firms. We accomplished that.

As you look at headcount numbers quarter over quarter, year over year, I wish we were recruiting at a faster rate more recently, you see no negative impact of rolling this comp plan out.

Hugh Miller - Sidoti & Co

Do you have a rough sense of what percentage of your brokers are impacted by? They were producing under $300,000 and would you anticipate that you will see some type of attrition because of the adjustment if they are feeling as though they are not able to get over that hump and that they are obviously going to have to be eating a lower payout and a lower income?

Jim Ross

We are still paying a 25% to 40% premium over the Street. A broker that wants to stay in the business looks out there at his alternatives or her alternatives. I have had a lot of one-on-one conversations and had a lot of discussions with the branch managers, with the Regional Directors. We talked about this particularly with our bigger producers, our President's Council producers for well over a year. We got a lot of input.

The simple answer is I don't expect attrition, I don't expect people to go forward. The exact percentage of people producing under $300,000, I don't have it, but I can get it for you.

Operator

Mac Sykes from Gabelli & Company, you may ask your question.

Mac Sykes - Gabelli & Company

If you could just give a little more color on the subsidiary that you talked about? Would it be approved by the regulators? What is really the reason for creating the sub? Would it have to have its own capital requirements? Just a little bit more color around that.

Jim Ross

Actually, you lost me here for a second, which is real easy to do. The subsidiary you are talking about?

Mac Sykes - Gabelli & Company

Yes.

John Holt

I can provide a little color on that. What we would be talking about is potentially evaluating a subsidiary where we you would transfer performing-type classified loans into the subsidiary, which would obviously reduce the classified asset ratio at the bank. Instead of having to sell the loans quicker, you would have more of a workout time period where you could potentially have a greater return, but that is just one of the many options we are considering. It certainly hadn't been determined.

Mac Sykes - Gabelli & Company

John, I am trying to understand how that would be more efficient than your structure now. Is there some kind of different capital requirement by isolating those assets as long as it is under the group level? What would be the economic reason for doing that? What I don't understand is the difference between say keeping those assets and just holding onto them versus putting them into a sub and letting them run off.

John Holt

Two things. One, you would be in a non-regulated entity as opposed to being within the bank would be the primary reason.

Mac Sykes - Gabelli & Company

When you talked about lowering the deposits, I apologize if I am a neophyte on this, could you explain a couple of ways that you would lower deposits to improve your capital ratios?

John Holt

The primary deposit we have is coming from the broker-dealer and the cash balances of those customers' accounts. There is other alternatives that we could offer the customer and directed it another fashion as opposed to being directed into the bank-insured fund at the bank.

Mac Sykes - Gabelli & Company

You would outsource those basically?

John Holt

There are several different companies that do that waterfall-type product. We've talked to them. We have looked at doing it ourselves and waterfall in the other way. Yes, there is opportunities to do that.

Jim Ross

I would just add to what John is saying. Our deposits come from, when we say the broker-dealer, both the PCG and the independent channel and then our correspondents, which we look at. We are committed to providing an FDIC-insured product at a very competitive, if not premium rate to those investors of our correspondents of PCG. We will not abandon that strategy should we look to reduce deposits and we have a lot of options and ways we can do that to make sure that we honor that commitment to the investor.

Mac Sykes - Gabelli & Company

My last question is, assuming that your Tier-1 capital dipped below 8%, you have to notify your regulators right away and then what is the grace period for getting back (inaudible).

John Holt

There is no defined grace period, but the actual 8% is core capital.

Operator

Aaron Kiddell from (inaudible) Capital, you may ask your question.

Unidentified Analyst

Are the loans that were moved to held-for-sale included in nonperforming assets as of 9/30?

John Holt

Yes, they were.

Unidentified Analyst

Moving to the brokerage side of the business for Jim and others, the commission revenue for the quarter was up sequentially, which is probably good given that it is usually a kind of seasonally slow quarter. Would you view that as a sustainable level as the brokers that have come on are becoming fully productive, either the independents or the employee owns and just give us some color on what you would expect to see from just the retail brokerage side going forward?

John Holt

I would view that as a sustainable level and a level that we can grow given the market. I am not trying to evade your question, but in existing market, not only stock levels and interest rates, etc., but when I say the market, the market as far as client sentiment expectation, etc. If you are a Republican, you think everything just got fixed last night and it is all going to be great. If you are a Democrat, I don't what you are doing today.

There are so many factors, but to specifically answer your question, the brokers right now are settled in and I see really good morale. I see more and more of product diversification among both the independent contractor, the PCG and we just had a meeting with our top 10 correspondents in talking about how they are handling these. Yes, I would be surprised if, given everything is held constant, if that is not a sustainable level and of course, our goal is to grow that.

Unidentified Analyst

Similarly, the investment banking revenue was the highest in eight quarters. I would assume you are being helped by pretty strong municipal activity, particularly in places like Texas where you are active maybe in California. Maybe just kind of similar question, just given what you are seeing out there, what would be your outlook for just the Institutional side of the business over the next foreseeable couple quarters.

Jim Ross

When I look at the Institutional side of the business, and Institutional to us is absolutely predominately fixed income, municipal, public finance. We look at that as one subset, taxable fixed income, then the corporate finance, stock loan, etc. I have conversations with the guys that are really smart in driving all of that, they feel that what they are seeing right now is a normalized level from particular highs a year ago and they are starting to feel good about growth from here.

We look to issue calendar in public finance, if you look at the performance in that subset within Institutional, if you look at where these guys are going with taxable fixed income and everything I see looking out past a year and such, we want to be more aggressive and we want to deliver a better product, better experience in fixed income across the board.

Whether you believe in higher taxes or whatever, I see retail, institutional, we want to be better, stronger and bigger player in fixed income. Corporate finance, we are just really getting some traction in there. I see a constantly improving pipeline. You see a lot more relationships. We have added some more people. The people that are coming on and joining that team just keep reinforcing we are making the right move as we are getting into corporate finance and as we see those markets open up to us.

Jim Ross

At this time, we don't have anymore questions on the call. I am being handed a an email question. Does SWS have its arms around the write-offs at the bank subsidiary? I am going to turn that over to John and I am going to make some assumption. Do we have our arms around the write-offs at the bank subsidiary? I am going to make the assumption here do we feel that we fully understand the issues before us as far as credit quality?

John Holt

Jim, that is what I understand as the question also and while we can't speak with any certainty given no additional decline in the economy, the credit quality issue should peak in the next couple of quarters and actually begin to improve. We have a lot of reviews that we do both internally as well as externally. Having recently completed a limited scope exam, we feel comfortable we understand our loan portfolio.

Jim Ross

With that, I will thank everybody for their time. We appreciate your support and we look forward to speaking with any of you one-on-one that would like to give us a call and thank you very much.

Operator

This concludes your conference call. You may now disconnect. Thank you.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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