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Executives

Jeremy Skule – Chief Communications Officer

Jon Corzine –CEO

Henri Steenkamp – CFO

Analysts

Richard Repetto – Sandler O'Neill

Michael Carrier – Deutsche Bank

Ken Worthington – JP Morgan

Howard Chen – Credit Suisse

Chris Allen - Evercore Partners

Rob Rutschow - CLSA

Ed Ditmire - Macquarie

Ken - Barclays Capital

MF Global (MF) F4Q 2011 Earnings Call May 19, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter and fiscal year 2011 MF Global earnings conference call. [Operator instructions.] I will now turn the conference over to your host for today's call, Mr. Jeremy Skule, chief communications officer. Please proceed.

Jeremy Skule - Chief Communications Officer

Good morning and thank you for joining us for our earnings call this morning. With us today are Jon Corzine, CEO; and Henri Steenkamp, our CFO.

The information made available on this conference call contains certain forward-looking statements that reflect MF Global's view of future events and financial performance as of March 31, 2011. Any such forward-looking statements are subject to risks and uncertainties indicated from time to time in our SEC filings. Therefore, future results of operations could differ materially from historical results or current expectations as more formally discussed in our SEC filings.

MF Global does not undertake any obligation to update publicly any forward-looking statements. The information made available also includes certain non-GAAP financial measures as defined under SEC rules. The reconciliation of these measures is included in our earnings release, which can be found on our website and in our SEC filings.

With that, I'll now turn the call over to Jon.

Jon Corzine - CEO

Good morning everyone and thank you for joining our call. Today Henri Steenkamp, our newly appointed CFO, and I will update you on our results for the fourth quarter and fiscal year 2011. We'll also discuss our progress in implementing our recently articulated strategic plan and the ongoing restructuring.

Let me begin by observing that over the quarter and through the fiscal year, we've achieved significant improvement in our financial performance, while building operating leverage for our future. The numbers posted on slide 3 present the metrics supporting this view.

That said, I want to emphasize that our fiscal 2011 performance in no way represents the firm's earnings or return potential. It does reflect the constructive transformation efforts we've undertaken, efforts we've consistently expected would take four to six quarters to complete. I'd also note that our improving results, along with our restructuring efforts, were executed in an environment that was a challenge for many financial firms, and most particularly for FCMs.

Restructuring and external considerations aside, as noted on dashboard 3, fourth quarter net revenue rose 22% over last year, the highest level in nine quarters. For the year, net revenues grew by 5%. Adjusted net income for the quarter swung from a negative $30 million a year ago to a positive 9.2% this quarter, and from a negative $18.3 million for the full year 2010 to a positive $46.6 million for 2011.

We believe these positive changes reflect our diversification initiatives and a more directed effort towards higher-return activities, activities that gained momentum as the year progressed. Revenue growth in the quarter, particularly, reflects the expansion of principal trading and client facilitation businesses, and indicates a better allocation of firm resources.

In addition, client volumes on exchanges grew by 20%, as we maintained market share on most of the major exchanges where we have a presence. We are also realizing substantial increases in employee productivity, which grew by 38% for the quarter and 11% for the year. The result certainly captures the simple arithmetic 12% reduction in staff year-over-year, but more importantly, it reflects a dramatic upgrading and repositioning of our people.

Over the last year, 969 employees left the firm, while 588 joined. That's off a starting point of roughly 3,200. Included in these staff adjustments has been a broad resetting of senior management, including a new president and COO, a new chief financial officer, chief risk officer, head of internal audit, regional leadership in Asia and Europe, new heads of global trading, sales, retail, and prime services.

In addition, we have added several hundred experienced market operatives - traders, sales, and support personnel included - and more in the pipeline. Just yesterday we announced the hiring of a new business leader for our global FX operations. Needless to say, we are adding and upgrading in those areas where we recognize the opportunity to align staff to strategy and quality to function in both front and back office.

During the quarter, and over the year, our compensation to net revenues moved in the right direction, although much more work is to be done. Key hires and defensive actions taken to retain critical staff impacted our quarterly sequential comp ratios but do not change our intermediate objective to drive compensation to revenues into the low 50s near-term, and to move lower than 50% in time.

As part of this effort, we have restructured the terms of employment for the vast majority of our producers, and we anticipate seeing the effect of these changes over the coming year. I do want to point out we did take several one-time charges in the quarter related to the ongoing restructuring, including severance and office closings of approximately $13 million and the impairment of intangibles and goodwill of $16.9 million.

In addition, we set aside $34 million in legal reserves, settlements, and related expenses. The majority of this reserve is for a number of legal cases related to pre-IPO business MF Global's predecessor conducted through [inaudible] introducing brokers. In the prior quarter, the effects of a recent change in German law caused us to reevaluate our potential for exposure and therefore we added to our legal reserves.

Increased revenue, improved productivity, and lower compensation expense to revenue has improved our EBITDA. As the dashboard indicates, our EBITDA expanded in fiscal 2011, growing 128% to $172 million. These improvements in financial metrics have been accompanied by a reduction of low-return uses of the balance sheet with gross leverage moving from 37 times to 27 year-over-year.

On the other hand, our net leverage ratio, which deducts Basel III assets, has begun to grow, highlighting our expansion and market making among asset classes offering potentially higher margins. Importantly, our client balances continue to grow, indicating or improving strength as a counterparty and building operating leverage in a rising interest rate scenario.

We have also taken important steps to improve our capital structure. During the year we have successfully issued equity and convertible notes, thereby extending the tenor of our capital, reducing high-cost debt and more appropriately staggering their maturities.

These actions give us greater flexibility to invest in our business and execute our strategy. We will continue to be opportunistic in tapping capital markets where those actions will strengthen capital and extend our capacity. [inaudible] serve our clients and generate returns.

While these results and observations do reflect a firm in transition, I repeat, we are constructive about the positive trends and believe our results and actions have increased operating leverage, laying the foundation for further improvement. Henri will give more nuance to our financials.

Moving on, slide four shows some of the progress we're making on executing our strategy. Over the last year, I've discussed at length our plan to diversify revenue by expanding our broker-dealer activities through [inaudible] and both client facilitation and proprietary activities. These efforts have already had a substantial impact on the firm's performance.

In the fourth quarter, revenue from these principal trading activities more than doubled from the same period last year. As a percent of total revenue, client facilitation and proprietary activities were 33% in the fourth quarter and 26% for the year, or nearly 17% higher for the quarter and 10% for the year.

Throughout the year, but particularly in the last quarter, we saw significant volatility across fixed income and commodities markets. Core commodity markets, European peripherals, and structured equity financing provided solid trading opportunities in the quarter. We expect these and other circumstances to continue across multiple asset classes in volatile markets. Our clients' demand for risk-intermediation services should parallel that volatility.

As we execute our plans and continue expanding our sales and trading operations, we would expect our capital commitments to increase. Undoubtedly, measured risk-taking will be a part of our buildout to an investment bank. The path to a more diversified revenue model may, from time to time, include periods of risk-concentration as opportunities present themselves and our business model matures.

That said, diversity of exposure and revenues is key to our risk management philosophy. It is from this perspective that we are committed to high turnover on our trading books, even as we expect the bar will increase to match the expected returns.

Slide five details the four business divisions and some of the specifics we've taken to execute on our strategic plan. While we are generally on an organic track and building out our strategy, we will regularly review other steps that could be accretive and accelerate our plan.

Within capital markets, we have significantly enhanced our sales strategy and cross-selling efforts while disaggregating retail client coverage. As noted, we have made significant hires in the areas where we see the greatest potential for growth. For instance, in mortgages, corporate credit, and commodity derivatives.

While we have seen short-term implications on compensation from upgrading talent, we are making long-term investments in our business by acquiring the skill sets necessary to build capacity. The increased risk intermediation services we provide to clients through expanded facilitation activities has already begun to impact both the top and bottom line.

In the future, we expect to integrate our strengths in commodities in natural resources with the capital markets' expertise we're putting in place, so to provide the foundation for more traditional investment banking services, such as structured products, underwriting, and advisory services.

Efforts are well underway in our retail division to globally align our brand, people, and products into a unified offering. While we have a broad global footprint and extensive product offering for retail clients, our approach to client service, marketing, and advertising will soon be focused and interconnected. All of our support operations as well as distribution, will be integrated and economies captured.

Our Prime Services division has begun to build on our market leadership in exchange-traded derivatives, futures, and options, along with our existing advantages in clearing across asset classes for small and mid-sized financial and commodity-oriented institutions. This business line already has a solid infrastructure and a client-service framework, which we are focused on standardizing across products and geographies.

Finally, as previously noted, we're seeking to further diversify revenue by leveraging our strengths in commodities by expanding into the asset management business. We continue to evaluate potential partners and opportunities as there is a growing client demand for exposure in mature and emerging commodity markets, we believe our experience within these markets across the globe can support an MF Global offering.

Certainly we have much work ahead of us as we complete our restructuring and execute our plan. Our strategy objectives will be leavened by our number one priority - earnings. Over the fiscal year, that means generating GAAP [inaudible] by the second half and in the intermediate term we expect to deliver double-digit returns on equity for our shareholders. The progress our firm has made in the last year speaks of MF Global's potential and our ability to achieve our objectives.

With that, I'll turn it over to Henri and I'll be happy to answer your questions.

Henri Steenkamp – CFO

Thank you Jon, and hello to everyone. I just wanted to start off by saying how excited I am to be part of the vision that Jon and the board of directors have set for MF Global and I'm really look forward to my new role within that vision.

These are exciting times in our transformation. As many of you know, I have been fortunate to work closely with Randy over the past several years, and his continued presence at the firm as head of retail has helped to ensure a smooth transition and very regular dialogue. I hope to continue adding greater transparency and insight to MF Global's financial model.

For example, we are considering changing the presentation of our income statement in upcoming quarters to better reflect the transformation of the company. This will likely include reorganizing our income statement to better reflect a broker-dealer business model in the short term and divisional reporting by business area in the longer term consistent with our strategy.

As Jon mentioned, the company has made significant strides over the past year and we are focused on maintaining our positive momentum and trajectory. Our strategy plan was approved in December, which set us on course to reshape MF Global into a full-service financial intermediary.

As we move into the implementation and execution stages of our strategic rollout, our commitment to earnings remains in focus. As we mentioned last quarter, expenses associated with our strategic actions may continue over the next two quarters as we continue to realign our people, structure, and systems.

With that, I'd like to start by walking you through how we get to adjusted EPS of $0.05. Let's turn to slide six. We start with our GAAP loss of $0.51 based on our common shares outstanding. Then we add the recurring dilution adjustment for our convertible debt and preferred shares, since we use the as if converted method to calculate our share count for adjusted EPS. Achieving dilution for conversion of these conversion of these instruments, we add back $0.10 for their antidilutive effect on our loss.

But what makes up the rest of the difference to get us to our $0.05 of adjusted EPS? There are effectively three items that were noteworthy that make up the rest. The first item third quarter was legal reserves. The bulk of the $0.12 adjustment primarily relates to a reserve for cases arising from pre-IPO business in Germany.

As Jon noted, these cases were filed by retail clients for losses incurred through former introducing broker relationships. While many of these cases are quite old, our previous reserves were less significant since we had been fairly successful in defending ourselves. However, a recent change in Germany case law began to impact our actual results and caused us to reevaluate our reserves. We therefore made an additional accrual for the total pending matters and on are fully accrued for all cases currently filed against us.

The next item of $0.08 reflects restructuring, severance, and other charges. This item was driven primarily by actions taken in order to align the company with our new strategic direction. This included termination of leases and personnel costs associated with closing the Paris and [inaudible] offices. In addition, there were other severance and benefits paid out to employees.

The third and final item of $0.06 reflects impairment and intangible assets and goodwill as a result of our annual impairment tests. The assets impaired mainly relate to customer relationships from the Refco, [Broker One] and FXA acquisitions.

When originally recorded many years ago, the anticipated velocity of trading and the assumed attrition rate reflected a much healthier assumption than the current environment would support. And our strategic decisions for this year have further impacted these future assumptions.

So adding these three items back gets us to the $0.05 in adjusted EPS. Let's now look at the details of our quarterly results, starting with net revenues on slide seven. I'd just like to say that it is my absolute pleasure in having the opportunity to discuss Randy's favorite slide.

To begin at row nine, total net revenues in column A were $292 million. That's our best performance in over two years. This reflects progress in our effort to diversify the revenue base by increasing principal trading and client facilitation activities as well as strong client volumes in our exchange-traded products.

Net revenues were up about $52 million from a year ago and $46 million from the December quarter. That's up more than 18% as compared to both periods. Column B presents our commission revenues of $125 million. That's down 6% from the same quarter last year, but up 3% from the December quarter.

We experienced strong sequential and year-over-year growth in our cleared commissions. However, our execution only revenue continues to face challenging comparisons. This is consistent with our restructuring of the IDB business at the end of fiscal 2010.

The good news is that this mix change continues to shift to clearing where we not only earn commissions, but also net interest income. Furthermore, our market share has stabilized as we have regained momentum.

Our volumes, which are in row 10, were $510 million contract, up 20% from the same quarter last year. This compares favorably to a 13% increase in exchange composite volume. On a sequential quarterly basis, volumes were up 20%. This exceeded the market composite increase of 15%.

We would expect to continue to move more in tandem with the overall exchange volumes prospectively. However, the mix of volume will continue to be more heavily weighted toward our cleared business, which is a lower yielding business than the execution only. As previously mentioned, we also earned interest on clearing business not reflected in our commissions yield. Therefore, this change in the mix of volume is demonstrated in both the lower yield in our blended [inaudible]

Looking at row 12, the yield in our commission-based business was $0.24. That's down $0.07 from the same quarter last year and down $0.04 from the December quarter, reflecting the shift of mix that I just discussed.

In column C, our principal transactions and related interest, these are revenues from all of our principal trading and client facilitation activities, our structured equity financing, and our core product areas, including fixed income, energy, metals, and foreign exchange.

Net revenues from these businesses totaled $109 million, up 102% from $54 million last year. That is also up about $42 million from the December quarter. This substantial increase reflects our continued focus on expanding principal trading and client facilitation activities as well as pockets of strength in commodities.

As Jon mentioned, we saw principal trading opportunities in European sovereigns this quarter. By entering into resell and repurchase transactions to maturity, as we do in U.S. government securities, we are able to capture arbitrage opportunities in these markets.

We believe the market risk to these trades is minimal as these are held to maturity. While we retain exposure to the underlying credit throughout the maturity period, the duration of these trades is short term in nature.

Additionally, we continue to reshape the balance sheet to capture higher margin opportunities and as such our [matched repo and stock borrow] loan book continues to move lower. You can see in row 13 our average balances for the repo and stock borrow loan book were reduced by 55% over the past year and 6% from the December quarter. As the incremental returns in this area continue to remain relatively low, we have reduced our lower-yielding [match] book.

Lastly, in column D is our net interest income from client balances and associated yields. In row 11, the average assets are $15 billion, which is $1 billion higher than last year and slightly up from the December quarter. In the row below this, row 12, is the net interest income yield of 134 basis points. This is 8 basis points higher than last year and up 2 basis points from the December quarter.

The increase in yield is especially noteworthy given only a 2 basis points increase in the effective fund rate from last year and 3 basis point drop from last quarter. We've maintained our laddered approach of maturities consistent with prior quarters, by extending approximately $8 billion, or 55%, of our average balances into longer-dated maturities. This compares to 48% last year.

The average maturity of the extended portion is 24 months compared with 16 months a year ago. The blended portfolio of $15 billion has an average duration of 12 months, up from 9 months last year.

We have seen some calls of our extended portion since our fiscal year end and this has resulted in a reduction of average duration to approximately 9 months. As we always do, we are currently evaluating short term opportunities to increase yield but balance it against the potential of rising rates.

So with the revenue picture now covered, let's review our progress on the cost structure on slide 8. [inaudible] comp ratio. [inaudible] made a number of new hires, upgrading talent as well as working to retain critical personnel. Approximately 45% of the ratio in the quarter was unique. 2-3% of this ratio was associated with payments to attract new, and retain existing, personnel, with roughly 2% from 40k and payroll taxes unique to the first calendar quarter of the year. Even with these items, the compensation ratio was 6% lower for the full year and 4% lower than the same quarter last year.

The improvement to our comp ratio is mainly due to higher revenues, a different mix of revenues, and expansion of the equity component of compensation. Equity now comprises 17% of total compensation granted in fiscal 2011 as compared to 6% in fiscal 2010. This further aligns our employees' interest with those of our shareholders and serves as a retention tool for our people.

Looking ahead, and depending on revenue levels, we anticipate the comp ratio will move back to the mid-50s range in the short term. Moving to the top right-hand chart, you see that our year to date non-compensation costs on an adjusted basis were down 2% from last year and down 6% quarter-over-quarter. While we continue to build out our infrastructure as part of the implementation of the new strategy, we will continue to focus on cost cutting initiatives and the creation of scale.

We expect non-compensation to be around $100-110 million per qualified for the foreseeable future. This is consistent with our commitment to ensure we adequately support the implementation of the strategic plan, including our revenue diversification initiatives.

Now turning to the chart on the bottom, you see the benefit from our focus on higher-margin activities and commitment to managing our overall cost structure. EPS on an adjusted basis for 2011 was $0.05 for the fourth quarter and $0.25 for the full year. That compares to losses of $0.17 and $0.11 for the same period last year. Moving to the chart on the bottom right, adjusted EBITDA increased 128% to $172 million in 2011, up from $76 million for the same period last year.

Now how has this change in the business model impacted the balance sheet? Let's review that on slide 9. Our focus on utilizing capital for higher-margin businesses as well as our efforts to optimize our capital structure have resulted in significant improvements to our balance sheet. Total assets on the balance sheet have come down 21%, from $51 billion last year to $41 billion this year, and equity has increased 7%.

Gross leverage ratio has declined to 27 times this year, from [57] last year, as we have resized the repo book and expanded our risk-taking efforts. As expected, we are seeing our gross and adjusted leverage ratios converging. Adjusted leverage ratio of 5.2 for fourth quarter was up from last year's 3.8, and flat sequentially.

If you'd now turn to slide 10, you can see the improvements to the capital structure. We were very proactive this year with our capital structure, working to diversify our capital, extend our maturities, increase the permanency of capital, and lower our weighted average cost of capital. Following our equity raise last summer, we were able to tender $94 million of the Series B preferred shares and $9 million of the 9% convertible notes.

Our revolving credit facility was amended and extended, with $690 million extended to June 2014 from 2012 and during the fourth quarter of 2011 we raised $287 million of convertible notes with a 1.875% coupon due in August 2016. Minimizing dilution for shareholders is important to us, so we coupled this with a core spread overlay.

With this hedge transaction, investors are not subject to any economic dilution from these notes until the stock reaches $14.23, and together with the cost of the core spread overlay, the effective cash rate for these notes is just over 4%.

We then used $150 million of these proceeds to pay down the revolving credit facility. We continue to evaluate the market for opportunities to optimize our capital structure and we intend, like most companies, to continue to be active in the credit markets in the foreseeable future.

How have these actions impacted our liquidity? Let's turn to slide 11. The company has $2.2 billion in total capital. We have $1.5 billion of required and nearly $400 million of excess capital sitting in regulated entities, and we also have $143 million of free cash in our financial holding company.

Moving down the page, the undrawn portion of our revolver, after the $150 million paydown this quarter with some of the proceeds of the convertible debt raise is still well over $800 million. We also have $1.5 billion of intraday liquidity in non-segregated client payables and collateral, and this adds up to total available liquidity of nearly $3 billion, which is very consistent for the past year. We'll also continue to draw down on the revolver at regular intervals as short term liquidity needs and market opportunities arrive.

So in summary, we made continued progress on our plan, which is beginning to manifest itself in our financial performance. With that, I'll now turn the call over to the operator so we can take some questions.

Question-and-Answer Session

Operator

Thank you sir. [Operator instructions.] We'll go first to Richard Repetto of Sandler O'Neill.

Richard Repetto – Sandler O'Neill

I guess my question is revenues grew nicely and you're attributing it to sort of the principal trading customer facilitation. And I guess the question is I'm looking at your [bar] - it really didn't change, so how were you able to accomplish it? And then going forward, if it looks like the expenses are going to be slightly higher, where are we in the process? Is there a little more growth in revenue to be generated from customer facilitation principal trading?

Jon Corzine –CEO

First of all, as it relates to the [bar], on the report, relatively stable, but if you look at the spikes inter-quarter, it's moved up and down. We have a high turnover philosophy with regard to our trading position. If you look at the correlation within the portfolio as we build it out, there are offsets that our risk metric systems and risk systems would offset, so it is a growing book, but it is not necessarily exposing us, at least at this point.

I believe there is substantial ability to grow that without really changing our risk appetite as opposed to our risk participation. We believe that with the substantial change in personnel, that I've indicated with the comings and goings, we are adding significantly to our distribution force. We are seeing many, many more opportunities. Some of those have come along with the primary dealership, which was announced during the quarter.

So there are a number of things that we think will expand our footprint in the client facilitation business. Maybe most particularly, that we've done a lot on disaggregating retail from institutional and getting our distribution folks focused attendant to the clients in a much more cohesive manner.

So I'm excited about what we can do in the client facilitation business over a period of time, certainly plenty of volatility. As an old washed up trader, I'd say volatility is our friend, and there's certainly a demand for risk intermediation services, and we look forward to it being an attractive period both on the principaling side and in the facilitation side.

Henri Steenkamp – CFO

And Rich, on the cost side, there's the two parts to the cost, comp and noncomp. On the comp side, I think there are the unique items in the quarter that we mentioned in the remarks, that we do consider unique. And we're expecting compensation to move down. I think on the noncomp you've seen an uptick, and there's a slight uptick, which I mentioned in my remarks on a quarterly basis, and I think that really reflects our investment that we have been marketing.

I think we're continuing to get scale from the technology that we have, historically. But our investments in technology we are now actually starting to use, which is contributing to some of that increase in expense. And then we are just continuing to invest in infrastructure as we diversify our revenues. That results in the increase in top line that you see.

Jon Corzine –CEO

I'd just add that as we integrate systems we think there will be savings in addition to the amortization of the costs that go, so it's a process of how you restructure to be able to handle the scale that we think we're building into our activities and interface with the market. Certainly our volumes would show that, and our position in the market, I think, is growing.

Richard Repetto – Sandler O'Neill

And then my one followup has to do with the legal reserve, the $34 million. I guess the question is how did that come about and do we expect any more of this? Was it related to customer balances or how did you come up with a number and how sure is it that we're done here on this?

Henri Steenkamp – CFO

You know, this related to a very specific item. Effectively the rules of the road sort of changed. Prior to the IPO, MF Global had introducing broker relationships in Germany, as I mentioned. And these relationships as you know very common practice in the industry. Some of these IBs lost money. And with the IBs now out of business, clients are suing clearing brokers across the industry, including us, to cover these losses. And very recently, the litigation environment changed. German case law created a precedent as a result of an appeals court decision against another firm that affected effectively the scope of both our liability and the size of the awards. And it's just resulted in more plaintiff-friendly verdicts. And so we, this quarter, had to adjust our accruals. But we are fully accrued for all cases that have currently been filed against us.

Richard Repetto – Sandler O'Neill

Okay. But I guess the question is could be there be allocations filed as well?

Henri Steenkamp – CFO

I think the answer to that is [inaudible] vigorously defend ourselves in these cases if more come about, but it's hard to predict. We're fully accrued for everything that we currently have.

Operator

And we'll move to our next question from Michael Carrier of Deutsche Bank.

Michael Carrier – Deutsche Bank

Just given the repositioning and buildout, and then the strength and the progress on the principal transaction side, I know it's tough to gauge, but when you look at the areas that you feel are kind of fully in place, versus where you still see more progress on the repositioning side, is there some way to kind of gauge where you're at in terms of the run rate and granted this line's going to be volatile. It's just part of the business. Just trying to gauge where you kind of see the different product areas, the different geographies, versus what the full potential will ultimately be.

Jon Corzine –CEO

Well, Michael, first of all, I think we're at the beginning, not the end of that process. We did not, when I joined, have a coordination of the trading and sales in client facilitation business that was organized in a way to get anywhere near potential. We are adding significant quality client-facing personnel with a trading group that understands its responsibility in facilitating that intermediation of risk. And I think there's enormous potential.

We've already gotten sort of into the mid-level in the government securities area. And as you've heard me say several times, the derisking and deleveraging that is going on among the bulge bracket firms is creating a real opportunity for midsized financial commodity firms. We've established significant relationships across the board. We're further along on our commodity business because we have a more historic position with clients. We are building that out.

I'm spending a lot of time visiting with clients, along with our sales force. The followups and consistency of that I think will pay huge dividends. We took on a new associates class this year that is now about 10 months into its term. Those people have been trained by pros now, and we'll be able to spot them in other areas. I think that this area is a tremendous growth opportunity in a period where there are fewer risk intermediaries and this deleveraging, derisking is going on.

And we already have a strong position in the futures and options on exchange connections with a number of people. We just have to leverage it. And I think we're making progress on that. We will continue to. And I think it will be very advantageous. We think that will also be accompanied by, in the kind of volatility that we see in multiple assets, classes, on multiple geographical bases, significant proprietary opportunities as well, which we are managing very, very distinctly apart from each other - the client facilitation and the prop activities. And so I think the diversification and the growth give me a lot of confidence for the future.

Michael Carrier – Deutsche Bank

And then just one number question. You guys did a good job just in terms of giving us adjusted numbers on the comp expense and the noncomp and even the outlook on both those areas. Just on the tax, there's a lot of moving items during the quarter. So is there, sort of what you would say like the clean tax number is, or just any clarity there.

Henri Steenkamp – CFO

Our tax rate was in the 20s for the quarter, as you know, significantly lower than the original guidance, because of some losses in higher tax jurisdictions and then also greater income from lower tax jurisdictions such as Europe, as we mentioned. Our tax rate guidance that we're thinking of for this coming year is still the mid to high 30s. I think we expect our tax rate to normalize more next year as we obviously don't anticipate repeated losses in some of the higher tax jurisdictions. And we think the profit's going to be more likely to be spread more evenly between the higher and lower tax jurisdictions.

Jon Corzine –CEO

The one thing that I would add to what I had said about client facilitation, we have not even begun, yet, the integration of our capital markets activity into serious structured product elements. And we think there is very, very significant near-term opportunity for us to play a role, particularly with mid-sized financial institutions, off the skill sets that we have today, let alone those that we'll be adding.

Operator

And Ken Worthington of JP Morgan has our next question.

Ken Worthington – JP Morgan

First, can you just further flesh out the mix shift from execution only to the clearing? I assume this is a proactive decision on your part, but can you talk about maybe why you're driving business kind of away from the execution only side?

Jon Corzine –CEO

Well, first of all, we think that execution only is not tied to a long-term firm to firm relationship. We think it tends to be a very limited contact point with people who we would want to evolve our relationships in a more signaling pattern as we grow into an investment bank. The history of the IDB business is really strictly focused on that single point execution and not a much greater cross-product relationship with our client. So that's the starting point. Where the clearing business is very key to developing a deep standing relationship which we think we can leverage into other kinds of corporate finance activities for the client. That also comes with generally higher balances as Henri pointed out in his remarks, and that in the long run is building earnings capacity, earnings power for the firm.

Ken Worthington – JP Morgan

And then just the followup. Given the turnover you're seeing, you've brought a lot of new people onboard at the company, what kind of flexibility do you have, say, on the compensation side, if market conditions were to become more challenging? What percentage of people would be brought on with one-year or multi-year guarantees? I guess maybe as a way to address that.

Jon Corzine –CEO

Multi-year situations are not a part of our pattern of bringing people on. And second, our whole objective is to align performance of the firm and the needs of our shareholders to compensation. And we've, as I pretty clearly noted in the remarks, we've gone line by line through this. We've got more work to do, but I think we've got a little more flexibility sitting here today than what we had when I joined the firm.

We will have more a year from now, and pretty close to that period of time I think we will have the kind of adjustment flexibility that I think is necessary in a business that has some volatility to it and we need to see that so that our shareholders are sharing in the long-term performance profile of what it is that we're building with our strategy.

I feel good about it. I think that that kind of change in the number of people in and the number of people out gives you a tremendous opportunity to reset this. Some of those people left because they didn't like the new program. Some of the people coming in know what they're taking on, because it's been clearly articulated.

Operator

And next we have Howard Chen with Credit Suisse.

Howard Chen – Credit Suisse

Jon, on the capital structure, you know you'd be opportunistic in terms of tapping the markets, but as you think about the long-term vision of the company, what do you ultimately want the optimal capital structure to be?

Jon Corzine –CEO

My optimal capital structure is built on retained earnings. That's why we are focused on getting to GAAP. That's why we're focused on ROE. The main way to generate capital and you then will have debt-to-equity capacity built, because you're generating internal capital, is our objective. I'm a very simple person about that, and I like the EBITDA, because we're generating cash that does that. That's another metric that I think one has to keep an eye on. But we want to do this internally as much as possible.

And we clearly were undercapitalized in my view, I didn't like our capital structure when I came in. I said that very clearly in the first quarter call. And we've taken steps to address those issues. We will continue to opportunistically strengthen this capital structure. It's not, long run, my desire to be using a liquidity facility for capitalization. So I think there's some pretty commonsensical steps that we will take, but the basic growth in book is what I'm interested in generating through retained earnings and we're hell-bent on getting there.

Howard Chen – Credit Suisse

Understood. And just on that point, Jon, could you just update us on your current dialogue with the ratings agencies? I know at least one of them has been focused on the firm achieving near-term profitability. That was a few quarters ago. You're trying to balance that near-term profitability with long-term vision, but do you anticipate any actions from them?

Jon Corzine –CEO

I think that as far as their benchmarking - I hope that's how you all take this - we'll see in the fullness of time. But I think we are meeting milestones and objectives that would indicate that we could get to that GAAP kinds of earnings.

If you turn to page 14 on this press release, and check off these adjustment items, and then try to think through - and nobody can predict with certainty the future, but you check through these things, how many of these things are repeat items in the future?

We think we can make a case to the rating agencies that we are on a pathway to getting to what they have expected us to do. That doesn't mean that they're telling us that now. They want to see it. It's show me time, and we have very consistent dialogue.

I think they are comfortable if not supportive of the kinds of steps we've taken to enhance capital and liquidity, but at least one of them is very clear about earnings. And I think that was in the context of an annual review, which is done end of December, first of January.

Operator

And our next question will come from Chris Allen of Evercore.

Chris Allen - Evercore Partners

Just wanted to ask if you could give us some color in any penetration of larger institutional accounts that have followed from the primary dealer designation and some of the new hires that you've made recently.

Jon Corzine –CEO

Well, there has been. Sometimes for good. It is an important element for us to move into having relationships with central banks, sovereign wealth funds, the major players in the marketplace. On the other hand, we can easily get up to our limits on what we're able to execute in some of those transactions unless people are willing to work with us on an order basis, which is not as typical.

I think our meat and potatoes will be by building up with mid-sized financial institutions and commodity firms and making sure that we provide a perspective on the market to the larger players. And we continue to demonstrate to them that we would be their partners in executing their major block trades. That's the strategy that we're taking in our sales. I think we're making some real inroads on that. We'll continue to try very hard to give reason for both large institutions, but very clearly for mid-sized financial institutions and commodity firms, to deal with us.

Chris Allen - Evercore Partners

So early innings with the large players.

Jon Corzine –CEO

Early innings, but it's different than it was. Before we weren't a primary dealer. We put out on the electronic exchange, or electronic connectors now. We're participating in these activities.

Chris Allen - Evercore Partners

And my one followup is any update in terms of where some of the current regulations, specifically any changes around Rule 125?

Jon Corzine –CEO

We're just as interested in that as everyone else is. It looks like it's been pushed out. Later in the spring maybe you'll come up with an answer, but we're of the view that this will have some modifications, maybe significant modifications, to the original presentation and I don't think there's a solid indication on timing. And as you know, the whole Dodd-Frank reform rule making process is getting pushed out. And I think this comes after that.

Chris Allen - Evercore Partners

Okay, and just the modifications that you think may happen, do you think they will lessen the severity relative to the FCM model?

Jon Corzine –CEO

I do, but I think that some elements of concentration will be more than likely reflected. And we don't think that should be terribly damaging. The piece that we're most interested in is intercompany repurchase arrangements and we're hopeful, but we don't think that it is life or death. But it would take a change in some of our methods of operation to be able to get this done.

You could make a negative case about segregation of collateral with regard to some of the derivatives that go on to exchanges. And we're working, as everyone, fully engaged in trying to make the case for how do we get optimum liquidity and safety for clients.

In presenting our cases, we think more participants, fully engaged in these price discovery mechanisms and exchanges, is good for the market. It actually spreads out capital risk, and I think the CFTC and the SEC have recognized that by not having these monstrosities of capital charges that some of the exchanges have tried to lay down. It's actually quite favorable.

So this is a mixed bag, and it's an uncertainty. When I made my comments, what our performance was, was done in the context of lots of uncertainty - low interest rates, uncertainty on regulatory environment, compression of spreads, rates. You can focus on all of those things. That's why we have been so committed to diversifying revenues so that we're not dependent on singularly the FCM model.

And we want to be prepared that we could give greater emphasis to other things if some of the changes came out adversely. We think are actually likely to support the FCM model on balance through this process, and be supportive, but we're not going to be so risk-concentrated in that business that we couldn't do other things.

Henri Steenkamp – CFO

We think that the commission's goal is protecting customer funds, and not necessarily changing things that work. And with the capital rules and other major [inaudible] participant guidance that came out, that's an example of where there's a recognition of the current capital rules actually work.

Operator

[Operator instructions.] We'll move next to Rob Rutschow of CLSA

Rob Rutschow - CLSA

I guess historically MF had talked about costs associated with trading errors of about 1.5% of revenue. You've revamped the systems, but you're also ramping up prop trading, so I'm wondering if this is still a relevant and good number. And if so, where would we look for that to show up in the income statement. And would it be kind of episodic as it's been in the past?

Henri Steenkamp – CFO

Yeah, I think we do still view that as a relevant metric. I think it's been always around the sort of 1.5-2.5%, and this quarter isn't too different from that. So I think it's a metric that is still very important for us and that we still look at.

Jon Corzine –CEO

We spend a lot of time on operational risk management in the firm, as do most firms today. But I think you will see that we are taking very real steps to address this. One of the reasons that we were excited about having Brad Abelow, who came in first as our COO and then now acting as our president, is that was his background in the securities business, tightly running a securities operations businesses.

And we will be taking additional personnel steps and technology steps along these lines, some of which are in the works, which I can't reveal, but we're absolutely dedicated to making sure that we minimize those numbers. We're not greater than have perfection, but minimizing those numbers. And like every financial institution, making certain that you don't have the kind of car crash that this organization experienced back three or four years ago is essential by having tight controls, tight compliance, and making it part of the culture. And that's the kind of people we're hiring, and that's the kind of culture we're building, and intending to. That should hold those down.

Rob Rutschow - CLSA

The second question I had, you mentioned that you hope to be GAAP profitable in the second half of fiscal 2012. So I'm just wondering what are some of the assumptions that go into that specifically? Are you expecting to get any help from rates? And I guess more importantly, does that mean that we'd be past the majority of the one-time charges at that point going forward?

Jon Corzine –CEO

I've tried to make clear in these calls that this was a four to six quarter process. If you look through, as I suggested, on page 14, the adjustment from GAAP to adjusted earnings, you could check off a number of these things as highly non-repeatable if you were done with your restructuring process.

We have a restructuring charge in there, and tangibles and goodwill. Hopefully we've made the good judgments about that, and that is behind us. The stock compensation related to IPO awards isn't going to be repeated. If we're doing a good job of hiring people, severance and benefit expense and plus we're changing those kinds of contracts. UK bonus tax, doesn't look like that would be repeated.

Something like the extinguishment of high-cost debt might show up again, because if we can restructure our capital posit to not be carrying high-cost debt, we will certainly do that, and I think the market would think that would be an adjustment that they'd like to see.

But I think you could go through those numbers and come up with a view that you could get to GAAP if we keep growing earnings, or keep growing revenues. And that is the task that all of us realize is our responsibility.

Operator

And our final question will come from Ed Ditmire of Macquarie.

Ed Ditmire - Macquarie

On the overall targets, it sounds like you're mostly focused on creating sold profitability at the bottom level for the company, but when you look versus last quarter, we had a big jump in revenue, but nearly all of that was offset with higher costs. It makes me wonder do you guys think that it's crucially important to get to a certain revenue level, maybe a tipping point, where enough scale will make higher margins much easier?

Jon Corzine –CEO

Well, there is a hockey stick element, if you could get to numbers on a breakout side. We're committed pretty regularly to talking about double digit returns and doubling our revenues [inaudible] over the years. And if we execute on plan, I feel good about repeating those and think that can happen. The cost structure, we've built a lot more variability into it. We talked about that within the context of the compensation discussions and it gets covered up in ratios, but ratios you can fix both by taking down comp or taking up revenues, and so your point about revenue growth is absolutely essential.

But I think that the numbers on expenses on the latest quarter, particularly on the comp side, pretty explicable. FICA kicks in heavily on high-income earners in the first quarter. So does 401k for that matter. And we play both defense and offense on inducements and retentions with the people we want here over a period of time, and took those expenses. And we don't think you're going to be looking at that kind of compensation to revenue ratio and we think there's a lot more flexibility in it.

We need to build a scale. We need a platform that allows us to scale our businesses. That means we have to make investments. When we make those investments, with some lag there will be expenses taken out. I'd like to be paying a lot less [inaudible] lot fewer vendors for [inaudible] bolt-on technology systems that we have that are a legacy of multiple acquisitions and decisions that were uncoordinated. So when you hear me talking about integrated and synergies, we think there's room for sustaining cost control. That doesn't mean that we're not going to invest in our systems. If we don't, we're not doing our shareholders justice about building capacity for the future.

Ed Ditmire - Macquarie

Maybe one follow on. Do we have enough revenues today to hit your GAAP profitability targets by the end of the year with the evolution and the cost base that you anticipate?

Jon Corzine –CEO

I think it has to grow. And we have every intention of making that happen. And the point you made and asked the question on, we are building to plan so that we're in that position whether interest rates go up or not. The risk that this organization and many SEMs have is that there is no diversification of revenue and you're sitting there betting on whether interest rates go up. It's actually one of the bigger market bets in a so-called agency business that mix, I think, the [inaudible] on these organizations a lot higher than it will be as we diversify out. And that's exactly what we're trying to do with building out our capital markets business, building out our transaction services business, and hopefully not too far down the road an investment management business. And I certainly believe that the early green shoots, if you will, of our capital market structured product stuff will be being weaned in as we go through the year.

Operator

And we will be taking another question from Roger Freeman of Barclays Capital.

Ken - Barclays Capital

Good morning guys. This is Ken for Roger here. Just had a quick question here on principal transactions given the large uptick this quarter. I think over the past few quarters we've seen areas within those line items, kind of like FX equities and commodities, the revenues decrease. And last quarter, for instance, we saw that kind of made up with repurchase agreements, accounted for sales which were like $24 million. Is there any way you could help us kind of think about the different drivers of that line and how to maybe forecast that going forward?

Jon Corzine –CEO

I think I tried to say this, and three things there is what you just mentioned on these sales and repurchase agreements. There is commodity trading, which has been quite successful, and some of our structured finance activities in equities. And we're contributing in a lot of other, smaller client facilitation activities that are include in the numbers.

Operator

And that does conclude today's question and answer session. I would now like to turn the conference back over to management for any additional or closing remarks.

Jon Corzine –CEO

Appreciate everybody joining us, and look forward to hooking up in another three months.

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