Lehman Brothers F3Q07 (Qtr End 8/31/07) Earnings Call Transcript

Sep.18.07 | About: Lehman Brothers (LEH)
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Lehman Brothers Holdings Inc. (LEH)

F3Q07 Earnings Call

September 18, 2007 10:00 am ET


Shaun Butler - Investor Relations

Chris O'Meara - Chief Financial Officer, Executive Vice President


William Tanona - Goldman Sachs

Guy Moszkowski - Merrill Lynch

Mike Mayo - Deutsche Bank

Glenn Schorr - UBS

Meredith Whitney - CIBC World Markets

Douglas Sipkin - Wachovia Securities

Jeffrey Harte - Sandler O'Neill & Partners



Welcome to the Lehman Brothers third quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Shaun Butler, Director of Investor Relations. Thank you. You may begin.

Shaun Butler

Good morning and thank you for joining us. Before we begin, let me point out that this presentation contains forward-looking statements. These statements are not guarantees of future performance. They only represent the firm’s current expectations, estimates, and projections regarding future events. The firm’s actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statement.

These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are difficult to predict and beyond our control. For more information concerning the risks and other factors that could affect the firm’s future results and financial condition, see risk factors and management’s discussion and analysis of financial condition and results of operation in the firm’s most recent annual report on Form 10-K and quarterly report on Form 10-Q as filed with the SEC.

This presentation contains certain non-GAAP financial measures. Information relating to these non-GAAP financial measures can be found under selected statistical information, reconciliation of average stockholders equity to average tangible common stockholders equity, and leverage and net leverage calculations in this morning’s earnings press release, which has been posted on the firm’s website, www.lehman.com, and filed with the SEC in a Form 8-K available at www.sec.gov.

With that, let me now turn the remarks over to Chris O'Meara, our CFO.

Christopher M. O'Meara

Thanks, Shaun. Good morning, everyone and thank you for joining us today for our third quarter update. As you’ve all seen in this morning’s earnings release, we posted solid results this quarter, despite what were extremely challenging market conditions.

Revenues in our investment management segment established a new record, while investment banking and equity capital markets posted their second-highest quarterly level of revenues ever.

Regionally, we generated 53% of our revenues outside the U.S., our highest percentage ever, which allowed us to achieve our second-best level of revenues in both Europe and Asia.

Strength in these areas helped to partly offset the dislocations we saw in the market during the quarter, which most significantly impacted the fixed income portion of our capital markets business, particularly in the U.S.

Market conditions were very challenging during the quarter, as what began as a broad-based reassessment of credit risk morphed into heightened liquidity and market risk over the course of the summer. Valid concerns regarding the underlying credit quality of sub-prime mortgages and related CDOs became more systemic as risk premiums became elevated and liquidity became scarce across asset classes, extending across rating categories into double A and triple A rated assets.

Spreads widened out accordingly, with high grade and high yield spreads essentially doubling over the period, representing approximately a five standard deviation move in percentage terms.

The repricing of credit risk had second order effects that extended into foreign exchange, as carry trades were unwound and into the global equity markets as financials repriced and investors sought liquidity. Volatility spiked in equities, interest rates, and foreign exchange, as investors rushed to buy protection, and correlations between asset classes moved towards one, as they generally do in a distressed environment.

Secondary markets in certain asset classes became illiquid, particularly in highly structured products. These market moves were exacerbated by concerns over the significant pipeline of high yield debt supply expected to enter the market, coupled with the de-levering of investment vehicles.

As risk aversion increased, investors horded liquidity. Consequently, asset repricing was amplified by the need to sell assets and raise cash. Certain hedge fund strategies were under pressure, given the market environment, which caused the combination of margin calls and redemption notices that required significant and immediate delivering. And liquidity risk was most acute in the asset-backed commercial paper market, where issuers were forced to raise alternative sources of liquidity.

This disorder in the front-end of the market, among other factors, prompted central banks to infuse substantial amounts of liquidity into the financial system. As a knock-on effect to market price deterioration and higher volatility, investment banking activity declined during the period.

On a sequential basis, the volume of announced M&A transactions declined 20%, equity underwriting volumes fell 5%, and debt underwriting volumes fell 29%. So overall, an extremely challenging backdrop for the capital markets during the period.

In this extremely difficult environment, we posted net revenues for the quarter of $4.3 billion, up 3% year over year but down 22% from the record we set last quarter. Net income was $887 million and diluted EPS was $1.54, including after-tax charges of $37 million, or $0.06 per diluted share associated with restructuring our mortgage origination platform, including the closure of BNC Mortgage, our U.S. sub-prime originator.

Our net income was down 3% and 30% respectively compared to the prior year in second quarter levels, respectively. Excluding the restructuring charges, net income was $924 million and diluted EPS was $1.60, both slightly ahead of last year’s third quarter. Return on equity was 17.1% for the quarter, well above our cost of equity.

We consider this a good performance, given the market conditions that prevailed in the third quarter. We attribute this performance to several factors: our strong risk management culture, with regard to the setting of risk limits and the management of market and counter-party credit risk, and our strong liquidity framework. And from a business standpoint, our growing footprints in investment banking, equities and investment management, as well as in Europe and Asia, which have reduced our reliance on any one business or region, and our continued emphasis on customer flow activities versus proprietary as a primary source of revenues, which has helped us to mitigate the impact of the difficult market environment.

Now let me review each of our three business segments. Starting with the Investment Banking segment, we posted revenues of approximately $1.1 billion, up almost 50% year over year and down 7% from last quarter’s record level. Despite the turmoil in the market, this represents our second-highest level of revenues ever in Investment Banking. It also marks the second time our quarterly revenues for this business segment have exceeded $1 billion. Our pretax income for this segment was $288 million.

Our M&A Advisory revenues were a record $425 million, up substantially from both benchmark periods. For the quarter, our volume of completed M&A transactions totaled approximately $111 billion. It is important to note that for the period, there was a significant amount of advisory activity not included in these volumes, from private deals where transaction sizes were not disclosed and therefore not included in the lead table data.

Our volume of announced M&A transactions totaled $156 billion as we continued to grow our pipeline, and our announced M&A market share rose to 20.2% year-to-date versus 15.7% for full year 2006.

So great progress in this franchise, as evidenced by our increased revenues, market share, pipeline and notably that we are advising on four of the top six deals announced in 2007.

In equity origination, our revenues were $296 million, up substantially year over year and down slightly from last quarter’s record level. This also represents our second-highest level of revenues for this business.

For the quarter, our volume of equity origination transactions totaled approximately $8.6 billion, down slightly from last quarter’s level and in line with the decline in the overall market. Although our results for the period declined sequentially, mainly due to somewhat lower convertible and derivative related activity, our IPO volume and market share increased in the quarter.

We were lead manager on the two largest IPOs in the quarter, Blackstone and MF Global, as well as on the IPO of VMWare, the best-performing IPO year-to-date.

Fixed income origination revenues were $350 million, essentially flat year over year and down substantially from last quarter’s record level. The decrease reflected the significant decline in both high yield and investment grade issuance activity caused by the dramatic credit spread widening we witnessed over the period.

Our volumes in both high grade and high yield origination dropped substantially for the period, along with the overall market.

Despite recent market conditions, we continue to have significant momentum in the investment banking business and both our volume and fee pipelines remain very strong. From a volume perspective, our pipeline across all products was a record $813 billion at the end of the period. Our M&A volume pipeline was $616 billion, equity origination pipeline was $18 billion, and debt origination pipeline was $179 billion.

Our aggregate fee backlog was approximately $1 billion at the end of the quarter, down from the record fee pipeline we had at the end of the second quarter but well ahead of where we started the year.

Moving to our capital market segment, we posted revenues of approximately $2.4 billion, down 14% year over year and down 32% sequentially. Our pretax income for this segment was approximately $715 million.

In the equities component of our capital market segment, we posted revenues of approximately $1.4 billion, up considerably year over year and down 19% from last quarter’s record level. This represents the third consecutive quarter that our equities business has exceeded $1 billion in net revenues.

We posted strong revenues in our execution services business, as both global market activity and our own client flow activity increased. Over the course of the quarter, volatility in the global equity markets increased substantially. For example, the VIX nearly doubled.

Consequently, we saw an explosion in derivatives volume, as both corporations and investors employed risk mitigation strategies. As a result, we achieved record revenues in this business.

Results in our prime broker and financing businesses declined from last quarter’s record level, due largely to the seasonal activity we saw in Europe last period. Also, although our number of prime brokerage clients rose in the period, balances were lower due to client de-levering.

Our convertibles business was negatively impacted by the spread widening and fixed income asset classes generally, and we saw weaker results in our merger arbitrage business, given general concerns over M&A completions and bid prices versus underlying stock values.

Lastly, gains from our private equity and principal investments declined from both comparable periods, with $40 million of losses for this period.

In the fixed income component of our capital market segment, we posted revenues of approximately $1.1 billion, down both year over year and sequentially. Our fixed income businesses were the most affected by the market dislocations, risk repricing and delivering that swept through the global capital markets this period. Consequently, the results we reported in the fixed income component of our capital market segment were impacted by some significant valuation movements.

On the one side, relating to assets and lending commitments, we recorded very substantial valuation reductions, most significantly in leverage loan commitments and residential mortgage related positions. These losses were partly offset by large valuation gains on the other side, related to economic hedges, short positions, and liabilities. We estimate that the result of these valuation items in the third quarter was a net reduction in revenues of approximately $700 million.

Our credit businesses were negatively impacted by the significant spread widening that occurred over the course of the quarter. From all-time tight spreads last quarter, credit spreads widened to multi-year wides.

The global high yield index widened 181 basis points, while high grade spreads rose 45 basis points. This risk repricing affected virtually all asset classes, including CDOs and emerging markets, and across the credit rating spectrum.

Like our financial instruments, our lending commitments are also mark-to-market. Due to the adverse changes in the credit markets that I noted earlier, we registered negative marks on our commitments during the period, though partially offset by gains on the other side, as I mentioned.

Revenues in our securitized products business were down versus both benchmark periods due to continued weakness in the mortgage industry, particularly in the U.S. Secondary trading activity remained active. However, we saw significant credit spread widening across the capital structure, including double A and triple A rated tranches, resulting in negative marks, even after considering hedges.

Our volumes for residential origination and securitization declined during the period. Our global residential origination volumes were $12.5 billion for the period, down 29% from the prior period, primarily driven by lower activity in the U.S. Our overall residential securitization volumes were approximately $23 billion, also down significantly from last quarter, driven by lower investor appetite.

Results in our commercial real estate business were weaker, due to spread widening and lower asset sale activity during the period. On the other hand, our liquid markets business, which includes interest rate products and foreign exchange, posted record results. Interest rate products reached an all-time high due to strong customer activity on the back of increased interest rate volatility, while the risk aversion rallying government securities also prompted strong levels of customer activity.

Foreign exchange also benefited from increased volatility, and the volume of FX activity was bolstered by the unwinding of carry trades.

Results in commodities increased significantly from both benchmark periods due to higher revenues generated from our power and gas businesses, and we have continued to expand our commodities business with the acquisition of Eagle Energy Partners, which has increased our presence in the physical markets for power and gas, and with the next phase of our build-out of metals trading.

Looking more broadly at the fixed income business for the quarter, we saw strong volumes from client activity as the market dislocations prompted significant asset reallocation and portfolio restructuring by investors.

Moving to our third segment, investment management, we posted record revenues of $802 million, up 33% year over year and up slightly from the previous record we set last quarter. Our pretax income for this segment was approximately $202 million.

For the asset management component of this segment, we reported revenues of $468 million, our highest level ever, up 34% year over year and up 2% from last quarter. We ended the quarter with a record level of assets under management, $275 billion, up 5% from last quarter, as we had net in-flows of $15 billion, partially offset by market depreciation of $3 billion over the period. Four-billion of the $15 billion of net in-flows during the period was from business acquisitions.

We have spoken in the past about our expanded marketing initiatives in the alternative space and our alternative assets under management now totals approximately $30 billion. Partially offsetting the increases in management fees were lower revenues from our minority stakes in hedge fund managers compared to the sequential period.

In private investment management, which encompasses our high net worth client distribution business, we realized record revenues of $334 million, up 31% from a year ago and up 8% from last quarter’s level, as our clients were active in both fixed income and equity-related products.

We ended the quarter with approximately 550 high net worth brokers with average annualized production of $2.5 million each for the period, both up versus the benchmark periods.

So our investment management segment continues to be a growing component of our overall business mix and from a revenue perspective, continues to be a stable source of revenues for the firm.

Now let me briefly review our non-U.S. results; for the quarter, our non-U.S. revenues were approximately $2.3 billion, up significantly year over year and down 13% sequentially. This is our second-strongest quarter ever from a regional standpoint. As I noted before, in total, our non-U.S. revenues accounted for 53% of the firm-wide revenues for the period.

In Europe, we posted revenues of approximately $1.5 billion, up 29% year over year and down 18% from the record level set last quarter. At the nine-month mark, we have now surpassed our full-year 2006 revenues in Europe. Similar to what we saw in capital markets in the U.S., we achieved our second-highest level of revenues ever in the equities capital markets in Europe, driven mostly by a strong performance in derivatives.

However, these gains were more than offset by the dislocations in fixed income markets, where we had strong revenues in more liquid asset classes, such as rates and foreign exchange, but under-performed in credit and securitized products. And in capital markets, we completed our first securitization through our Dutch residential mortgage origination platform during the period.

Revenues in investment banking in Europe were a record for the period, due to strength in all the major product categories. We also executed several large derivative transactions for banking clients in the quarter.

Despite the recent market turmoil, we continue to believe there will be more rapid growth in the capital markets fee pool in Europe over time. We have expanded our footprint accordingly, including in the Middle East and in Eastern Europe.

In the Asia-Pacific region, we posted revenues of $728 million, up 79% year over year, down 4% from the previous record we set last quarter. This also represents the second-highest level of revenues for this region. In Asia capital markets, our results were strong in interest rate products, equity derivatives, and prime services. We also led a successful, $550 million commercial mortgage-backed securitization transaction in August. We continued to make progress in investment banking where, in the quarter, we acted as book runner on nine equity transactions, raising $4.5 billion, including offerings for three Indian companies.

Our footprint in Asia continues to grow, most notably in India, where over the course of the quarter, we acquired Bricks Securities, a Mumbai-based brokerage house, purchased a minority stake in a local investment banking firm, and also received non-banking finance company approval to expand our operations in that country.

Moving briefly to expenses, for the quarter, we posted a compensation to revenue ratio of 49.3%, a level consistent with the ratio we realized in 2006 and in the first half of this year.

Over the period, our headcount rose approximately 2% to approximately 28,800. This reflects the annual addition of our analyst and associate classes and the incremental headcount from a number of small acquisitions, partly offset by a reduction in staff in our U.S. mortgage origination business.

For the quarter, our non-personnel expenses totaled $979 million, up approximately 7% from last quarter’s level. Forty-four million of this increase is due to charges associated with restructuring our mortgage platform, including the write-off of $27 million of good will from BNC mortgage, our U.S. sub-prime originator. These costs are included in the other category, the other expense category on the income statement.

Excluding costs related to the restructuring of our mortgage platform, non-personnel expense rose 2% as brokerage and clearance expenses increased due to the heavy volumes in both fixed income and equity related products, and we also incurred additional occupancy costs in all regions.

Taking all of this into account, we reported a pretax margin of 28% for the quarter; our effective tax rate was 26.4%, reflecting the larger pretax contribution from outside the U.S., as well as the lower level of pretax income overall, and the lower level of pretax income that we intend, that we expect to make for the period, where we had to catch up through the third quarter. We had to have two quarters of catch-up on the tax rate to get us to the run-rate that we expect for the full year. Our return on equity for the quarter was 17.1%, and our return on tangible equity was 21.1%.

We consider these to be good results, given the distressed market environment and a demonstration of the benefits we are deriving from our business diversification and strong risk and liquidity management, as I mentioned.

Now let me make a few comments about our balance sheet. We ended the quarter with total stockholders equity of $21.7 billion, while our long-term capital position rose to over $141 billion. Over the course of the quarter, we repurchased 9.6 million shares at an average price of $66.58 per share, bringing our year-to-date stock buy-backs to a total of 37.8 million shares.

Book value per share increased to $38.29, up about 3% during the period and approximately 13% year-to-date. We ended the quarter with a net leverage ratio of approximately 16 times, and our average historical simulation value at risk increased to 96 million in the current period, reflecting a combination of higher levels of volatility across a range of products for the period, and a higher level of risk associated with an increase in fixed income related assets.

Next I’d like to discuss our liquidity position, which is now stronger than ever. As we have discussed with you in the past, we have structured our liquidity framework to cover our funding commitments and cash outflows for a 12-month period, without raising new cash in the unsecured markets or selling assets to generate cash.

Our holding company liquidity pool, which has invested in cash and liquid assets, was a record $36 billion at the end of the quarter, up from $26 billion at the end of the second quarter. This does not include the significant additional liquidity pool at our regulated banks and broker dealers.

This corresponds to a record cash capital surplus at our holding company, which is the excess of long-term funding sources over long-term funding requirements. In addition, these measures all exclude unencumbered collateral of over $50 billion available to the holding company and over $50 billion of additional unencumbered collateral in our regulated banks and broker dealers.

Our conservative liquidity framework is based on the following principles: no reliance on short-term, unsecured funding, including asset-back commercial paper; illiquid assets are funded with long-term capital, with the remaining life of 12 months or longer; short-term secured funding is only used where there are deep, liquid, repo markets; long-term sustainable funding sources are developed to diversify funding, including at our three deposit-taking bank entities, two in the U.S. and one in Germany.

We have seen no reduction in access to secured funding in the repo markets, and we face very little refinancing pressure, with only small amounts of debt maturing the near-term, which is a consequence of our efforts to extend the average life of our long-term debt over the past several years and to limit the amount of debt that is maturing in any three, six, or twelve-month timeframe.

To reiterate, our liquidity position is stronger than ever. We consider our liquidity framework to be a competitive advantage, which positions us to support our clients and take advantage of market opportunities, even in a stress environment.

Before we move on to outlook, I wanted to make a few comments about fair value and marking to market, as I know it has been a subject of much discussion in the marketplace.

First of all, we carry all of our financial instruments, inventory and lending commitments, at fair value. We have a robust process in place in which employees, independent of the businesses, review the marks for accuracy or reasonableness, using all information available in the marketplace, including third party pricing sources, where applicable.

At the end of the quarter, approximately 90% of our inventory positions are classified as either level one or level two under the new FAS-157 GAAP hierarchy. At quarter end, we had non-investment grade contingent acquisition facilities of approximately $27 billion, down from $44 billion at the end of the second quarter.

Many commitments in place at the end of the second quarter have since come off. Of the $44 billion of commitments in place at the end of the second quarter, only $17 billion of these commitments were still in place at the end of the third quarter. Most of the $10 billion of new deals, to get us to $27 billion, so we went from $44 billion down to $17 billion, and then add $10 billion of new deals since the end of the second quarter, most of those $10 billion of new deals we’re committed to in the third quarter had more favorable terms for investors, in sync with the current market environment with respect to rates, flex, and covenants, which should enable us to syndicate them more easily.

Of the second quarter period end commitments, roughly $4 billion was funded in our inventory at the end of the third quarter, spread across 15 transactions. And to give you a little better idea of what goes into developing the mark on our lending commitments, we make no assumptions with respect to the probability that deals may not happen, i.e. we mark the entire commitment 100%. We do not assume that the terms may be restructured prior to funding. We mark the commitments in their component pieces, be they senior loans or bonds or pick notes, et cetera. We mark them to the current fair value yields, which is our best estimate of where these assets trade in the marketplace currently.

Although some of our specific high-yield acquisition commitments have not traded in the market, others actually have traded, which gives us current, new issue valuation information.

The biggest LBO deals have not built full order books from investors in this distressed liquidity market, but there is price discovery of real world trades to provide information about where the prices need to be to get the trades done in an orderly manner.

Although each of our commitments has unique circumstances, which means that this can’t be a perfect science, we feel very good about the information we’ve used to determine the marks and importantly, we’re always looking at activity in the market to confirm the marks. In this regard, we’ve seen some transaction activity subsequent to the end of August, which we believe validates the values we’ve assigned to those positions.

So overall, despite the fact that some amount of judgment has to be used in determining fair values in a distressed environment, we feel very good about both our process of marking to market and the marks themselves. Historically, our prudent approach to valuing positions has proven out in past distressed environments.

On mortgage positions, we saw significant spread widening in the quarter in all products. Given the nature of the asset class, many of our mortgage positions are mark-to-market using valuation models. The underlying inputs of these models are based on market activity and there has been a significant number of real world trades executed in the market which are used to validate our marks. And although many of these assets don’t appear to be trading at their fundamental values, we have marked our book to the actual prices being transacted in the market.

Fair value means marking to levels at which the assets will trade; not where we think they should trade. Said differently, it’s important to know that the inputs to our valuation models, such as credit loss assumptions, prepayment speed, and investor yield requirements, are calibrated so that the output prices from these models are consistent with real world trades being done in the market. And these are the same models we use to value client collateral that we take in against secured lending.

We feel very good about the marks that are on these positions, despite the fact that this market has come under significant liquidity stress and activity levels, particularly in the junior securities of capital structures, have been reduced significantly.

Our mortgage and mortgage-backed inventory increased during the period by less than 10%. The amount of our U.S. sub-prime mortgage inventory at quarter end was $6.3 billion, which includes those amounts we have sold to third parties but have to gross up under FAS-140 -- I’m sorry, it excludes, the 6.3 excludes those amounts we have sold to third parties but have to gross up under FAS-140.

Of the $6.3 billion of sub-prime assets, $5.4 billion is whole loan inventory, the vast majority of which was originated within the last six months. And of the remaining $900 million, $230 million are below investment grade securities and the rest are investment grade securities.

At quarter end, we had in total approximately $1.6 billion of non-investment grade interest in residential mortgage securitizations, including the $230 million in sub-prime I just mentioned. This is down slightly from the second quarter level.

Looking forward, our outlook is cautiously optimistic and our stance is constructive and opportunistic. Looking at past credit corrections, the capital markets have proven to be resilient, with previous dislocations lasting three months on average.

In the past, and we believe the current situation is no different, central bank actions have served to reestablish investor confidence while higher yields eventually attract buyers to the markets.

Credit spreads had moved to all time heights and have now reverted to their historical means, so a more balanced risk/reward dynamic exists in the market today. In the aftermath of the recent sell-off, we anticipate that there will be some intermediate term effects in the broader marketplace. Lower leverage will be employed and higher subordination will be applied to a number of financial products. We also expect investors to rely less on historical realized risk and return as a gauge for future returns and instead use more fundamental research analysis for their investment decisions.

Hedge funds will focus less on leverage and more on capital protection. Loan only investors will face higher volatility and higher risk but should earn higher returns over the long run, and demand for highly structured product will moderate for some time.

The global economy has been hit by two shocks; a U.S. housing recession and a capital markets liquidity squeeze. As a result, we have made some downward revisions to our projections on global economic growth. However, these figures remain generally constructive. Our outlook is for global GDP to grow 3.2% in 2007, a slower rate than was realized in ’06 but still a level that remains high enough to provide a favorable underpinning for our sector. This is important, since it remains the key variable driving continued capital markets expansion.

We also expect growth rates to remain higher outside the U.S., and this is where our expanded global footprint aligns the firm with broader opportunities going forward.

We also expect central banks to be supportive in sustaining positive economic growth, either through rate cuts or a cessation of hikes during this period of financial market stress. Corporate profitability remains healthy, balance sheets are strong and liquid, and all of this bodes well for continued growth under the assumptions the fed is successful in navigating the U.S. economy away from a recession.

Our global growth assumptions also underpin our view on investment banking activity going forward. We expect announced M&A bonds to finish the year up 15% to 20% versus ’06, with strategic buyers who currently comprise 75% of M&A, accounting for a larger proportion of overall deal volume, and stock to become a more prominent consideration in transactions.

Given the changes we have seen in cross currency rates and the current trade imbalances, we also expect cross border M&A and international activity to increase. Higher equity market volatility will most likely cause equity issuance to be down for the remainder of the year. However, we do expect a strong level of offerings from the financial, tech, energy and industrial sectors over the coming months, and we still expect fixed income origination to grow to over $10 trillion for the year 2007, with increased activity from non-U.S. borrowers more than offsetting a decline in mortgage securitizations.

Despite credit spread widening, absolute rates for high grade borrowers have changed little due to rallies in government bonds. We are also seeing large numbers of borrowers terming out commercial paper, given the shape of the credit curve, and various parts of the structured bond market have reopened recently, as we have successfully executed a limited number of transactions in NBS, CNBS, and CLOs over this difficult period.

In the equity capital markets, we have witnessed mostly positive performance in the month of August and total returns year-to-date running at 4.5%. We expect a full year return of about 10% in local currency turns in equities, while projecting corporate earnings to increase 9% in 2007.

Valuations remain attractive, even after adjusting for higher risk premiums, which should bolster market activity, and given what the markets have been through recently, we expect active risk mitigation strategies to continue to be important tools for investors globally, particularly institutional investors.

Fixed income capital markets will continue to face some uncertainties over the near term. Issues in the asset-backed commercial paper market still remain to be resolved, as programs are unwound, re-equitized, or funded in the term market, although recent information indicates some improvement in the short-term market.

The same is true in a number of other structured products. Investor confidence needs to be further restored and investors are looking to central bank policy to provide them with more conviction. However, fixed income investors cannot stay on a buying strike for extended periods of time, due to the inherent cash accumulation and portfolios from regular coupon payments and maturities. By our estimate, approximately $2.6 trillion of cash globally is coming due to investors through year-end from interest payments and redemptions.

Since cash carries a zero duration, this automatically shortens an investor’s average interest rate sensitivity at a time when most investors want to be long duration.

Yields on broad classes of fixed income securities have now become extremely attractive. We are beginning to see more activity in leverage financed loans, and we are seeing the formation of a number of new investment pools to take advantage of pricing dislocations in various fixed income asset classes.

Customer activity continues to be high, with significant portfolio reallocations and rebalancings occurring to take advantage of the significant opportunities that now exist. In general, higher volatility is beneficial for a number of our businesses, particularly fixed income and equity derivatives.

In addition, higher volatility, as well as wider [bid] spreads, provide more profitable training opportunities in the secondary markets, and given the strength of our customer franchise, we expect our capital markets revenue base to benefit from this trading opportunity going forward.

Barring any unforeseen circumstances, we feel that the worst of this credit correction is behind us. We have taken significant negative marks across all asset classes this period, and we have taken actions to resize our mortgage origination platform in line with what we believe will be a smaller securitization market for the foreseeable future.

In 2007, we have made some great strides in the commodities space, in our global rates business, and in emerging markets. Our investments in banking, equities, investment management, and outside the U.S. have been paying back, such that we’ve been able to mitigate the impact of a significantly lower mortgage business run-rate all year. As pricing continues to stabilize, we expect to see revenue improvement in our credit spread related businesses going forward into 2008.

Let me conclude by noting that this was an extremely challenging period in the global markets and although we were clearly impacted, we were able to navigate these markets fairly successfully and post a solid financial performance. We would attribute this success to our better business mix and geographic mix today, as well as our strong risk in liquidity management. We believe the current markets will present us with a significant number of trading opportunities as a result of the market dislocations, and we currently have ample liquidity and capital in place to enable us to successfully meet these challenges, capture these opportunities, and continue to grow our businesses over the long term.

I’ll be happy to take questions.

Question-and-Answer Session


Our first question is from William Tanona – Goldman Sachs.

William Tanona - Goldman Sachs

Thanks for the additional color on the marks there for both of those portfolios, but I think it would be also helpful if we could get those broken down by what were the leverage loan commitments and then what were the mortgage-backed security hits, on both a gross and a net basis?

Chris O’Meara

Well obviously they are big on both sides, the hedging programs as these instruments move, the hedging that is employed, the dynamic hedging strategies, particularly around the mortgage business, which is a business we have always had a full set of hedges on, will move with it. Knowing the gross numbers particularly in that business, I don't think is really a meaningful thing.

On the leverage loan side, we did take very significant hits as we have mentioned, and we sized that by saying they were in excess of a $1 billion, and not a small amount in excess of a $1 billion. Not $50 million or $100 million more, but I don't want to give the details of it. It may put us in a position where some investors might try to figure out what those marks are, and we don't want that. We want to competitively keep that to ourselves. But they were significant and we are marked at the current market.

William Tanona - Goldman Sachs

I know it is early just yet, but can you give us a little bit of commentary of what you have seen thus r far in the first couple of weeks in September across all of your businesses?

Chris O’Meara

It is early, and we don't give guidance on future periods, but as I mentioned, I think the worst of this credit correction is behind us.

William Tanona - Goldman Sachs

Great. Lastly, as you think about the FIC business and make the adjustments for the 700 net marks in that business, it still looks like FIC was down sequentially, but listening to your commentary it sounded like commodities was stronger quarter-over-quarter rates, and foreign exchange were also stronger quarter-over-quarter, so were the underlying businesses in both just credit and mortgages down on a sequential basis? If you could give us some type of magnitude in terms of what each of those businesses might have been up or down, or at least give us the degree of which was worse in terms of its level of decline?

Chris O’Meara

The liquid markets business which includes rates and foreign exchange, as I mentioned the foreign exchange business was strong, but it is a relatively smaller business for us, and the commodities business which is largely the energy business for us, is a relatively new business for us, so it is working off a small base and growing. So, those two businesses don't carry a lot of sort of relative weight in terms of their size contribution to the revenue base, so they won't really drive the results, but they are showing good signs of growth.

On the other side , the mortgage business as you know, was the origination side continues to be underchallenged the securitization levels were lower, the spreads, the revenue spreads that we have been making off those are lower as well, so that running rate continues to be relatively low by historical standards. But the reality is it has been in the second quarter FIC was very low as well. So I would say on that estimate of the $700 million impact net of all of the different valuation items, really sort of tells the story about what the difference is there versus the normal running

William Tanona - Goldman Sachs

But was credit down more on a sequential basis than mortgages were?

Chris O’Meara



Our next question is from Guy Moszkowski – Merrill Lynch.

Guy Moszkowski - Merrill Lynch

I wanted to ask you if you could, if you just could clarify that on the LBO commitment marks, if spreads were not to widen any further on those types of assets, you would then not expect that you would have any further declines in those commitments, is that correct?

Chris O’Meara

That is correct.

Guy Moszkowski - Merrill Lynch

So essentially then what you are saying is that you really have marked all of the commitments, even if they were deals that were not going to fund until well in the fourth quarter, et cetera?

Chris O’Meara

That is correct.

Guy Moszkowski - Merrill Lynch

With the marks that were taken to the mortgage portfolio, mortgage inventory, was the bulk of those marks within the net $700 million applied to the $11 billion or so securitization residuals including the non-investment grade stuff that you were talking about?

Chris O’Meara

Yes, but the marks, there was credit spread widening across all assets but your point is right. The bulk of it was to the lower-rated instruments.

Guy Moszkowski - Merrill Lynch

Can you give us a rough idea of the percentage of that net writedown of $700 million that was in the U.S. versus international?

Chris O’Meara

Most of it was in the U.S. Percentage-wise, actually I don't know that. Most of it -- I don't even want to guess -- but it is more than 50%.

Guy Moszkowski - Merrill Lynch

Now, your leverage increased both gross and net sequential quarters. Is it fair to assume that part of that was because you had to book some assets that you would not normally have wanted to book, but were a result of commitments?

Chris O’Meara

It is very small amount of that, Guy, so the amount that we actually have on our books from the commitments that were here at the end of the second quarter that have channeled through the system, we own about $4 billion of funded positions from that $44 billion that we had on at the end. The commitments, what formerly were commitments, many of them were funded, sold into the market, many of them fell away because we were paired up with other financiers and we had booked the commitment in at 100%, but we wound up being 25% in the end, for example. $4 billion of that, of the amount of that reduction came on to our books as funded positions.

Guy Moszkowski - Merrill Lynch

Right, so not that big a deal. How about commercial paper facilities and things like that, that might have dumped some assets on to your books? Did any of that happen?

Chris O’Meara

No. Our involvement in that commercial paper and the asset-backed commercial paper market is one of a dealer remarketing agent to the world, not as a principal, and so we have had very little that we have positioned in our books.

Guy Moszkowski - Merrill Lynch

So basically, despite the deleveraging that you pointed out that was taking place in the market, and among some of your clients and everything, your balance sheet isn't actually reflecting that? In other words, if I backed out the $4 billion or so that was sort of involuntary asset growth and everything else, I wouldn't see a net deleveraging of your balance sheet in the quarter?

Chris O’Meara

Deleveraging, no; what you might see is that the mortgage positions are up a bit as we have continued to originate, albeit at a slower pace, and we're originating and the securitization levels are down, so we haven't securitized everything that we have originated, just given where the market is. So we've built up a little bit although it's not a real significant amount, we have built up some whole loans that are going to be delayed in securitization given the market conditions.

Guy Moszkowski - Merrill Lynch

Let me ask you one final question, which is sort of an outlook question for really 2008. You talked about how you expected that the securitization markets and the structured product markets would probably be somewhat subdued, and obviously the core profitability of some of those types of businesses has been pretty high. In the scenario that you are currently contemplating where some of that stuff is weaker but as you said, some of your commodities and other buildouts are going to help offset that, is it wise for us to expect that your Fixed Income business can produce similar margins to what it had been say over the four quarters or so prior to this quarter? Or should we expect that margins probably would be a little weaker?

Chris O’Meara

Let me make a comment first on the structured products business. I do think that you will see a slower level of origination, but I do think there are different opportunities that present themselves in this type of dislocated market, and there are really trading opportunities, so I think the revenue generation will be less about new issue origination and more about working with investors about restructuring their portfolios and trying to transition out of certain of those structured products, and working with them in the secondary trading market. So I think there are opportunities there that will fill in part of the revenue slowdown that I would expect on the new issue side.

But there are lots of different businesses that are inside this Fixed Income series of businesses, and I am encouraged by seeing the benefits that we derive, even within that -- forget about all of the diversification that exists globally and in Investment Management and Equities and Investment Banking -- just within Fixed Income where we talked about the rates business, the FX business, the commodities business coming up, there is a fair amount of diversification that's in there.

So the securitized products are certainly an important element of what is in there, but they have been performing in a lower, they have lower performance in the last couple of quarters, actually for this year, than they had been in the year past, so I think other businesses have grown up into filling in that space, and I wouldn't expect a real significant fall-off on balance across these different asset categories.


Our next question is from Mike Mayo – Deutsche Bank.

Mike Mayo - Deutsche Bank

I am going to try again on some more detail on this $700 million reduction. How much were the hedging gains?

Chris O’Meara

It is just hard when you look at all of the component pieces that go in here, Mike, to break them out individually. I think the pieces, each of these businesses -- and I think this is tough to tease out is -- each of these businesses has long positions for assets that are in many cases themselves hedges against derivatives, where clients own returns on a synthetic basis and the assets themselves are hedges, so it is hard to say how much of the assets declined and the hedges made, but the hedges can be on both sides of this ledger.

What we estimate this mark to be, the 700, is if you just looked at all of the positions and just said if all of the positions stood still and we just took all of the marks on both sides of the ledger, including mark-to-market of the as I mentioned the shorts and liabilities, you will get to the 700.

I think of that as saying, that all happened as a result of this massive credit spread widening that we saw in the marketplace, and that is how it behaved in all of its components, I mean all of its parts taken together, and so if we don't see credit spread widening in the order of magnitude that we have, I wouldn't expect to see those amounts come through. Likewise if we see it going the other direction, I would expect to see that reverse, at least to a large extent.

Mike Mayo - Deutsche Bank

Well let me drill down on the leveraged loans then. You went from $44 billion down to $17 billion before adding anything new. Can you tell us what happened from the $44 billion to the $17 billion?

Chris O’Meara

I can give you, if I could, some of the broad items that are in there. Some deals got completed, and that is an important part here. The world is saying none of these deals are getting done, that is just not right. The biggest deals are not getting done, at least they have not filled to full order books, but there are many deals that are in the $500 million to $1 billion range that have actually gotten done.

So we have seen from the $44 billion that we had, we had a number of situations in which as I mentioned, we committed to a deal, we had some situations in which the deal we committed to actually fell away, the sponsor we were backing for example, didn't win the property, and so that commitment fell away. We had situations where the sponsor did win the property, but used multiple financiers instead of one financier.

The one other thing here is there is in our $44 billion, we know that we had in there situations where we signed up for 100% commitment for a deal, and we know that other financiers, other dealers signed up for 100% commitment to that same deal, so the sponsors frequently ask their financiers, multiple ones to present full financing packages for these deals, and so once they win the property, then they will invite all of the financiers to come in together in many cases, and sometimes you will be in at a three or four-handed deal, and so that will reduce the amount of our commitment, and that is a substantial amount of the reduction from $44 billion going down to the $17 billion.

Plus as I mentioned, deals got done, some of the commitments were sold away, where we risk mitigated those, or sold them away to other parties as commitments, so there is a combination of those situations that are in there that got us down to the $17 billion.

Mike Mayo - Deutsche Bank

You said the hit on the leveraged loans was well above $1 billion?

Chris O’Meara

I didn't say the words well above, but I did mean that, yes.

Mike Mayo - Deutsche Bank

On the $44 billion base that implies you took 3% or so markdown on those loans.

Chris O’Meara

The $44 billion, don't forget a lot of that 44 billion fell away, so when you mark those positions, positions that fall away don't get marked, right? You look at this thing and there are certain things where look at when the credit spread widening took place, which was part way into this period, and many of those commitments were not with us at that time. So really we have got to look at the positions we got pared down out of, they don't represent marks for us.

Mike Mayo - Deutsche Bank

What would be the denominator, in other words $1 billion plus hit on what base?

Chris O’Meara

I don't want to give you the specifics of that, Mike but we did take full marks on these.

Mike Mayo - Deutsche Bank

Even if it was on the whole $44 billion and a bit above $1 billion, that would imply 3% or possibly more of a hit.

Chris O’Meara

You would expect it to be more, just based on that, but Mike, the thing is about each of these deals, they are marked in their component pieces. Every deal is unto itself. There are some deals that are going to be marked significantly back. It is not every deal gets a blanket, let's just put a blanket mark on these. Each deal is marked not just the deal itself, but some of these deals have several, in some cases different traunches of the instruments in their capital structure and the debt capital structure, and each one of them is marked by the desk that trades in that instrument, and so they are closest to what is happening in the real market around that, and that's how they are marked.


Our next question is from Glenn Schorr - UBS.

Glenn Schorr - UBS

You touched on it briefly but can you talk a little bit more about the Level 3 assets? I think there has been enough focus there, but just give some context versus last quarter's $22 billion? I know there is a lot of moving parts in what falls in there. You might even want to comment to clarify for people what falls into the Level 3 bucket and what it looks like relative to last quarter?

Chris O’Meara

Level 3 assets are those that require the most significant amount of management judgment in determining the market value. So, they are fair value, all the assets are at fair value, Level 3 are those that, on the levels of 1, 2, and 3, Level 3 are the ones that require the most management judgment in determining their value. It typically relates to things like private equity instruments, where there has to be a lot of judgment, because these instruments don't trade and sometimes don't have anything that looks like them that trades that looks sufficiently like them, so we use judgment in determining the values on these. We had $22 billion of that at the end of the second quarter, as you mentioned Glenn, and that number will be higher this period, as we would expect.

We are thinking right now and we're still finalizing this, but that will represent about 8% of the total assets that get marked, the inventory, and that that would be higher percentage-wise and dollar-wise, maybe it would be 10% or 11% to think.

Glenn Schorr - UBS

And just conceptually, why wouldn't we expect it to be lower, given, I think maybe the misnomer but the concept is that things that require the most judgment might fall into that structured and less liquid camp, and would have wider bid asks one quarter later. You would think value adjustments might hit there and bring that number down. Why would we think of it to be higher?

Chris O’Meara

What do you mean by valuation adjustments? If the spreads widen out and liquidity pulls away, they are harder to value. The market value certainly will go down, but they also could slip into the Level 3 category, because there is not enough good price discovery in the marketplace, so they require some judgment.

Glenn Schorr - UBS

Was there a lot of movement, Level 2 down to Level 3?

Chris O’Meara

Yes. There will be movement from Level 2 down to Level 3, particularly at certain of the mortgage products.

Glenn Schorr - UBS

Is it true that the SEC was in last week just looking at everybody's books making sure that there is some level of consistency between mortgage leveraged lending, Level 3 and the like?

Chris O’Meara

Yes, Glenn I can't comment on specific regulatory matters, but we certainly have dialogue with the regulators, who are like everybody else, who is an interested party in the firm and but overall, we are overall under CSE, Consolidated Supervised Entity, we are regulated by the SEC at the holding company level. On specific matters of individual things, we are just not going to comment on.

Glenn Schorr - UBS

Understood. In your text, you said these losses were partially offset by large valuation gains on economic hedges -- that I get -- and then other liabilities. What are the gains that you get on other liabilities that act as an offset to the valuation reductions?

Chris O’Meara

Well, all of the instruments that are mark-to-market in the books, so it will be the hedging instruments whether the derivatives or short positions that are in inventory, or in a case where we have designated some portion of our structured notes that we have issued will be mark-to-market as well. All of those items will on the liability side will generate gains in a credit spread widening environment.

Glenn Schorr - UBS

Just part of the overall dynamic hedging process then. In other words, to your point on the growth getting down to the net, without a further deterioration in the high profile mortgage structure credit leveraged lending credit spread markets, we should not expect to see this sort of net valuation adjustment in the fourth quarter?

Chris O’Meara


Glenn Schorr - UBS

Last question, goodwill? It went up a bunch. I know there were a few acquisitions. I didn't think it was that big, and just to make sure that I heard you correctly, you said the writedown was only in the $23 million range on BNC of goodwill?

Chris O’Meara

$27 million.

Glenn Schorr - UBS

What produced the upward?

Chris O’Meara

Well, Eagle Energy Partners was one of the acquisitions we acquired, Lightpoint Capital, I mentioned in India, we had the close-up of Campus Door which is our student loan originator, a couple of small things in the Investment Management business as well.


Our next question is from Meredith Whitney – CIBC World Markets.

Meredith Whitney - CIBC World Markets

First on the European markets. Understood that the housing decline and securitization volume has been an issue that's gone on for a few years now, but given the declines in August on asset backed and securitization in Europe, and more of your revenues are coming from that, do you expect a sort of a hockey stick return to more normalized volumes this month, next month, and the month forward? That is just my first question.

Chris O’Meara

Okay, I think that the securitization markets are challenged globally. I think Asia has been less affected, so they are challenged. Deals are getting done. They are just getting done at spreads which are very challenged; when I say spreads meaning revenue spreads to the dealers. So folks are making choices about executing securitizations or holding off until it is more liquidity support comes into the market.

I think that this is something that will be challenged for a little while, but it's like past cycles, this doesn't go away. It sort of temporarily resets, reassesses the risk/reward paradigm, and then investors come back in when they are more comfortable that the right risk/reward is in play in terms of the yields they are going to get for the different parts of the capital structure they invest in.

Meredith Whitney - CIBC World Markets

Just to clarify on that point, the trends in Europe should mirror trends in the U.S?

Chris O’Meara

Maybe not exactly, and it depends on there are certain types of assets that might be less affected, but certainly as investors reassess the amount of subordination that is in the deals, particularly on investors who are investing in the top of the capital structure, I think it will take a little bit of time for them to reassess and get comfortable just generally. But it doesn't mean deals aren't going to get done. It just means that there is going to be fewer dollars at least for some period of time, but as I mentioned before, as the yields adjust those investors will be there for the right yield. It just takes some time to get through.

Meredith Whitney - CIBC World Markets

My second question if I may relates to expenses and hiring. Even if I take out the BNC increase in expenses in other expenses, the expense ratio was still higher than I would have expected, or certainly still higher than a quarterly trend rate. As a result I was wondering, are you going to continue to see pressure there?

From a hiring perspective, you guys have been building out more aggressively than others outside the U.S. Are you guys finished there, or are you almost finished there, therefore can we see more operating leverage coming out of your model over the next several quarters? Just some color on that, please?

Chris O’Meara

On the non-personnel expenses if you strip out the charges associated with the mortgage restructuring we are up about 2%. We have announced two different mortgage restructurings. One of them is in the third quarter numbers and the other one is not, so the other one happened in the fourth quarter, so we have another whatever it is, 800 people that we are taking out in the fourth quarter for a decision that was made in the fourth quarter. That will result in, together with some amount of the cost of closing down BNC, actually hits us in the fourth quarter the non-personnel cost, because of how you take it under accounting.

When you exit leases, is when you actually take the charge for them, so there is some element of that non-personnel expense that will hit us in the fourth quarter, plus we will have the non-personnel expense for restructuring, the non-BNC businesses that we have. So we would expect that non-personnel expense in the fourth quarter to be something in the neighborhood of $20 million. If you look at that other expense category that has the $44 million in it, in the third quarter you can expect that to come down by that $44 million, be hit with $20 million in the fourth quarter and then what we would see is some amount of continuing expense increases, which represent the continued footprint, that buildout of the footprint we have particularly around occupancy and technology.

I would say that we would be kind of around the number that we posted here, maybe modestly higher than the number that we have posted here in the third quarter.

Meredith Whitney - CIBC World Markets

Then for hiring?

Chris O’Meara

Hiring, we have largely completed the hiring program that we had in place at the beginning of 2007, so that was a successful build out, and we feel great about it. We want to try to get at the hiring decisions and get the people in the house as early in the year as possible, and we were successful in doing that in 2007. I wouldn't expect a significant amount of additional hiring here in the fourth quarter, but as we go into next year, we will be making decisions around our business plan and hiring coming into next year. But in the fourth quarter I wouldn't expect hiring, in fact I would expect a net reduction in people, just because of the mortgage restructuring that we announced earlier in September to end the year.

But going into next year I would expect us to continue certainly depending on the market environment, but if all goes as I would expect, I would expect us to continue on our build out program and begin hiring again next year.


Thank you, our next question is from Douglas Sipkin – Wachovia Securities.

Douglas Sipkin - Wachovia Securities

One, just hoping you can provide a little bit of color around the fee pipeline. You mentioned that it was still roughly $1 billion. I am trying to get color around how do you weight some of that? It seems like it is a pretty high number considering how the high yield market has changed so dramatically and probably will be a very difficult M&A environment at least in the short-term. I am wondering what sort of probabilities do you place around that to come up with that number?

Chris O’Meara

Once the deals are announced we put them in there. More than half of that fee pipeline is in the M&A advisory, so these are deals that are announced and they are just on their way to completion, so that is more than half the total. We have reduced the leverage finance fee pipeline to reflect that in deals where we actually have had to markdown positions. We are going to make no fees on those deals so we have reduced the leveraged finance pipeline to recognize that as any of those situations, we have eliminated any fees that we expect to get from those deals that we have marked down the positions to a loss.

Douglas Sipkin - Wachovia Securities

So that is reflected in your debt fee pipeline at the end of your third quarter, the fees that absorb losses?

Chris O’Meara

Yes, that is the biggest change that we have from the end of the second quarter to the end of the third quarter, the biggest single item reduction in the fee pipeline is in leveraged finance.

Douglas Sipkin - Wachovia Securities

If you can shed a little bit more light on I guess the hedging benefits. As you mentioned in your press release, hedging benefits and other liabilities, how should we be thinking about the other liabilities piece. Can you maybe just walk us through how that flows through your income statement?

Chris O’Meara

We mentioned the hedges, short positions, and other liabilities. Other liabilities are the instruments that are mark-to-market, and for us it is our structured notes that are liabilities on our balance sheet, and as time goes on it depends on what our own credit spread does, and how we mark-to-market those liabilities. They are mark-to-market instruments, in the same way that the trading positions are mark-to-market

Douglas Sipkin - Wachovia Securities

I am just curious because your financing costs on your own paper go up in the quarter, so I am just trying to understand how that would be an offset to a loss on the asset side?

Chris O’Meara

Well what it does, it re-marks your debt so that your financing costs looking forward reflect a more current yield that you would pay in the marketplace, because if our debt spreads move out a bit, it just means our cost to generate new debt would cost more so the accounting within FAS 157 sets up so you mark-to-market the debt that you have outstanding so that the interest rate yield that you are paying through your Income Statement looking forward is consistent with what you pay in the market.

Douglas Sipkin - Wachovia Securities

Finally,$2.6 trillion is expected in cash coming through in 2007. Is that correct in terms of coupons and maturities on Fixed Income instruments?

Chris O’Meara

That is just from the end of August through the end of the year. That is not for the full year. It is just from the remaining four months of the year.

Douglas Sipkin - Wachovia Securities

I know it is early into 2008 but do you guys have any preliminary forecast for 2008 global Fixed Income origination?

Chris O’Meara

We don't have them yet, but we should be getting them at some point, and we will make sure we get them out to you.


Thank you, our next question comes from Jeff Harte – Sandler O’Neill.

Jeffrey Harte - Sandler O’Neill

A couple of questions , starting with Fixed Income capital markets, I am trying to separate at least in my mind the impact of marks relative to activity levels. Am I thinking about this wrong to take the $700 million in marks you disclosed net for mortgages and leveraged loans, and kind of add that to the $1.1 billion in revenues you showed, and get something in the neighborhood of a $1.8 billion number?

And if I compare that to prior periods given how tough the quarter was, it would imply that activity levels stayed awfully robust, and that actually the marks are the driver of the softness here, and if activity levels continue like this, that could be good news moving forward. Am I thinking of that

Chris O’Meara

I think that is a fair assessment the way you have just described that.

Jeffrey Harte - Sandler O’Neill

More specifically on the Investment Banking side and I am even looking more at M&A, can you talk a little bit about whether financial sponsors are actually still looking at targets, and maybe if they are, how much that slowed? What has been going on as far as strategic client dialogues? Has that been kind of accelerating through the summer, or has that been pretty slow as well?

Chris O’Meara

Well we have seen just a tremendous amount of dialogue that is happening, and financial sponsors, they are professional money managers, and so they are out there constantly looking at different opportunities. They recognize that the cost of debt is increased, and they have got to factor that into how they are going to bid on properties and prices, et cetera, And expected IRR's that they are going to get, but that is a very, very active segment of the M&A market in terms of the dialogue that is going on. It is constant.

On the strategic side, there continues to be dialogue, maybe people have pulled back from actually going forward on some deals, but the dialogue is absolutely happening, and I think for us certainly we want to stay very close to these clients, because through this kind of situation, opportunities will emerge, and certainly you want to be prepared for them, and ready to move on something as the market firms up here.

Jeffrey Harte - Sandler O’Neill

Finally, can you give any kind of idea as to how important say the financial sponsor business is to overall revenues? I mean, we know there is M&A fees along with it, but when you start getting into any hedging revenues, trading revenues, setting up the financing, a slowdown or a pick up there, how meaningful is that to the overall franchise?

Chris O’Meara

It is an important part. It is not dominant by any means, but like this big diverse set of businesses we have, it is one of them and if it doesn't go away, it will be, you know, softened a bit here, but it is not going to have a real meaningful impact in the long term around the franchise. There are lots of other things that happen as a result of financial sponsor transactions in terms of foreign currency hedging opportunities, derivative opportunities, future liquidation opportunities, through IPOs or whatever, so it is a business we want to be in, we are committed to, we will continue to be in it, and if it slows down a bit here, that is okay. It is not going away. It will be back even if it takes a little bit of a breather.

Jeffrey Harte - Sandler O’Neill

Looking at BNC with that being closed out, we have talked a lot about expenses. Is that going to have any revenue impact going forward, or looking at last quarter was that more or less revenue flat to begin with?

Chris O’Meara

I think about it as revenue flat, so I wouldn't expect it to have a significant impact from here. We will still be interested in securitizing these assets. We can acquire them in the market as opposed to originate them, and if the business comes back we will be prepared to originate those out of our U.S. originator, that was formerly Aurora Loan Services, which is now Lehman Brothers Mortgage Capital.

Thanks, everybody for joining us. We look forward to speaking again soon. If there are any follow-up questions, please call either Shaun or Elizabeth. Take care.

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