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Executives

Shaun Butler - Director of IR

Chris O'Meara - Global Head of Risk Management and former CFO

Erin Callan - CFO

Analysts

Guy Moszkowski - Merrill Lynch

Mike Mayo - Deutsche Bank

Meredith Whitney - CIBC

Glenn Schorr - UBS

William Tanona - Goldman Sachs

Douglas Sipkin - Wachovia Securities

Lehman Brothers Holdings Inc. (LEH) F4Q07 (Qtr End 11/30/07) Earnings Call December 13, 2007 10:00 AM ET

Operator

Good morning and welcome to the Lehman Brothers' Fourth Quarter Earnings 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

Thank you for joining us today for our fourth quarter and year-end update. 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 of any such forward-looking statements.

These forward-looking statements are inherently subject to significant business, economics 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 conditions, see "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Firm's most recent annual report on Form 10-K, and their quarterly report on Form 10-Q as filed with the SEC.

This presentation contains certain non-GAAP financial measures. The 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. This release has been posted on the firm's website, www.lehman.com. It was also filed with the SEC in a Form 8-K, available at www.sec.gov.

This morning I am joined by Chris O'Meara, our Global Head of Risk Management and former CFO, and Erin Callan, our newly appointed CFO, who will be conducting these discussions in the future.

Chris will be reviewing our results for the fourth quarter and will provide an update on certain key exposures of our fiscal year-end. Erin will then discuss some of our key accomplishments in 2007, while providing a framework of how we are thinking about our outlook going into '08. Chris?

Chris O'Meara

Thank you, Shaun. Good morning, everyone, and happy holidays. As you have seen in this morning's earnings release, we posted respectable results this quarter in what became an extremely difficult market environment as the period unfolded.

Despite the market turmoil during the quarter, we achieved record results in both our Equities Capital Markets business and Investment Management segment. Regionally we generated 52% of our revenues this quarter outside the US, our highest proportion ever. Clearly the strength in these areas helped to partly mitigate the significant dislocations and supply/demand imbalances in parts of the US and European fixed income businesses over much of the period.

Let me start with the overall market environment. In the first part of the quarter we saw stabilization and then a recovery in both the corporate debt and the equity markets, underpinned by interest rate relief provided by the Fed.

However, conditions reversed dramatically in November as we saw a major wave of risk aversion prompted by rating agency downgrades of certain structured products, asset repricing leading to large write-downs, unresolved issues with [SIVs], and dislocations in the interbank market. These factors resulted in higher risk premiums across the board and fundamental questions about the valuation of securities.

In Fixed Income, US credit spreads hit multiyear wides with investment grade spreads at their widest level since December 2002, and high yield spreads at their widest level since July 2003. As a result, November was the single worst month on record for US investment-grade corporates and asset-backed securities, tallying negative excess returns ranging from negative 300 to 338 basis points.

This dramatic spread is widening, and it lead to Flight to Quality as the two-year treasury rallied over a 100 basis points, and the yield curve steepened. The equity markets followed a similar pattern rallying in the first half of the period. This was mainly in response to a larger than expected cut in interest rates, a general feeling that the credit crisis was behind us, a sentiment that there would be a soft landing, and the DOW reaching a new all-time high.

The sell-off in the later part of the quarter reflected weaker corporate earnings, renewed concerns about credit and the consumer, oil reaching all-time highs, and a further slowdown in housing. Volatility rose dramatically. In fact, it was the most volatile November for the S&P 500 since 1987. The Investment Banking weaker valuations, higher credit spreads and increased volatility in the secondary markets also had a negative impact on underwriting activity. Industry-wide fixed income underwriting volumes fell 29% on a sequential basis.

With slower financial sponsor activity, due to a large overhang of deals and weaker financing markets, the volume of announced M&A transactions declined 28%. And equity underwriting volumes dropped in the Americas and Europe, the markets most affected by the downdraft. So, overall this was a very challenging backdrop over the period.

In this extremely difficult environment, we posted net revenues of approximately $4.4 billion, down 3% year-over-year and up 2% from last quarter. Net income was $886 million, down 12% year-over-year and flat to the sequential period. Diluted EPS was $1.54, down 10% year-over-year and flat to the sequential period. ROE, return on equity, was 16.6% for the quarter, and return on tangible equity was 20.6%. We consider this a reasonable performance in light of the difficult conditions that prevailed over the period.

We attribute this performance to several factors. From a business standpoint, it reflects our growing footprints in investment banking, equities and investment management, as well as in Europe and Asia, which have reduced the proportional contribution of any one business or region.

It also reflects our commitment to customer-flow activities versus proprietary as the primary source of revenues, which has helped us mitigate the impact of difficult market environments, as institutional and high-net-worth investors remain active. More fundamentally, it reflects the strength of our risk management culture in terms of managing our overall risk appetite, seeking appropriate risk reward dynamics and exercising diligence around risk mitigation.

And lastly, it reinforces the importance of our disciplined liquidity and capital management framework, which sets us up to operate our business through periods of market stress.

Now I'll review each of our three business segments. Starting with Investment Banking, we posted revenues of $831 million, down 3% year-over-year and down 22% from the sequential period, due to the weakening market climate, which I mentioned earlier. Our pre-tax income for this segment was $207 million. Within the segment, our M&A advisory revenues were $388 million, up significantly from the year ago period, but down somewhat from last quarter's record levels.

Nevertheless, this represents the second highest level of quarterly revenues ever for the M&A advisory business. For the quarter, our volume of completed M&A transactions totaled approximately $380 billion. We advised on three of the top four deals completed in all of 2007.

Our global announced M&A market share rose to 17.3% year-to-date, versus 15.5% for full year '06. And our completed M&A market share rose to 20.9% year-to-date, versus 15.8% for full year 2006, all in a calendar year basis. So, we had strong share gains in this business overall.

In Equity Origination, our revenues were $210 million, down 6% year-over-year and a decrease of 29% from last quarter's level. For the quarter, our volume of Equity Origination totaled approximately $4.6 billion, down significantly from last quarter's level with convertibles accounting for a significant part of the decline. Despite a particularly difficult IPO market, where many transactions were pulled in the period, our IPO franchise realized particular success. For the quarter, we ranked number one in US IPOs, and we had a 13.8% market share as we completed transactions for Och-Ziff, DuPont Fabros and SandRidge Energy.

Fixed Income origination revenues were $233 million, down significantly from both benchmark periods. This was due to the weakness in the leverage loan and high yield markets as the credit spread hit their wide for the year, as was noted earlier. This deterred a number of high-grade and high-yield borrowers from accessing the markets. And despite these pressures, we ended the quarter on a positive note, leading the $6 billion preferred transaction for Freddie Mac, something Erin will discuss in more detail later on.

Despite recent market conditions we continue to have momentum in the Investment Banking business. Although our aggregate fee backlog of over $800 million at year-end was lower than its peak during '07, it is 7% higher than it was prior when we started 2007.

Over the course of the year, we made significant progress in building market share in M&A, IPO's and high-yield, and we led transactions for a number of new clients in a broader range of geographies than ever before.

Moving to our Capital Market segment, we posted revenues of over $2.7 billion, down 10% year-over-year, but up 12% sequentially. This segment absorbed the bulk of the risk re-pricing we witnessed over the period.

Our pre-tax income for this segment was $761 million. In the Equities component of our Capital Market segment, we posted record revenues of approximately $1.9 billion, up significantly versus both benchmark periods, and reflecting the higher revenue run-rate we achieved in this business all year. These gains reflect our broader customer franchise around the globe, where for the current quarter our sales credit volumes were up by 66% versus the prior year's period. As a result, we posted higher revenues year-over-year in our Execution Services business, driven by significant increases in our European and Asian franchises.

Results in our Equity Derivatives business continued to be strong as market volatility remained at far higher levels, and we tripled our results relative to the comparable 2006 period. In prime brokerage, our balances rebounded from third quarter levels, and given the relative stability of our franchise, we added 45 new clients over the period, bringing our total client base to 630 at year-end.

Our principal trading strategies were also stronger versus both benchmark periods.

Lastly, gains from private equity and our investment in GLG were approximately $500 million, significantly higher than both comparable periods.

In the Fixed Income component of our Capital Market segment, we posted revenues of $860 million, down significantly from both benchmark periods. Compared to last quarter's results, the variance was the result of a contingent that was broader in the current quarter, and compensated more asset classes in regional Europe as well as the US.

This impacted our business in three major ways. We had negative marks on our Fixed Income inventory. In some instances, our risk mitigation strategies were less effective as correlations broke down, and we incurred a higher degree of basis risks. Heightened risk aversion was among investors, which caused them to shift their trading activity to higher quality and more liquid products, which tend to be less profitable for the firm.

Now I'll walk you through the valuation adjustments. For the period, we incurred a net revenue reduction from position valuation changes of approximately $830 million in our Fixed Income Capital Markets business. Most significantly, this was in residential and commercial mortgage related positions.

On a growth basis, these valuations changes reduced revenues by approximately $3.5 billion, including $2.2 billion from our residential mortgage business. We had gains on hedges of about $2 billion which reduced the aggregate revenue impact from $3.5 billion negative to $1.5 billion negative.

Additionally, the impact was further reduced by two items: approximately $320 million of realized gains from the sale of certain leverage lending positions during the quarter, versus their valuations at the end of the third quarter; and approximately $320 million of gains on our structured note liabilities under FAS 159 and FAS 157.

As a result, revenues in our residential mortgage business were negative for the period, given the significant asset re-pricing that extended across sub-prime, Alt-A and prime mortgage product, coupled with declines in both origination and securitization volumes.

On a positive note, we posted reasonable results in secondary trading, particularly in synthetics, where we are a major market maker, and Asia securitizations, which was less affected by the sub-prime contingent in other regions.

Results in our Commercial Real Estate business were weaker, due to the spread widening and a lower number of securitizations during the period. However, our results in credit improved versus last quarter, as the market recovered in September and October, such that we were able to realize gains on certain leverage lending positions as transactions closed and distributed, as I mentioned previously.

A number of product areas benefited from the heightened risk aversion. Consequently, we saw a year-over-year improvement in liquid markets, including interest rate products in foreign exchange and commodities. This is also reflective of our larger scale in each of these businesses.

Lastly, while our customer franchise remained strong, the magnitude of the market dislocations in November caused overall customer trading activities to slow, and migrate into more liquid products. As a result, our sales [price] in Fixed Income dropped approximately 20% sequentially, and they were 8% lower than the average for the first three quarters of '07. So clearly, this was one of the most difficult quarters we have seen in Fixed Income.

Now, moving to our third segment, Investment Management: We posted record revenues of $832 million, up 30% year-over-year, and a 4% increase over last quarter's record level.

Our pre-tax income for this segment was $261 million, as we continued to benefit from our expanded presence in higher margin asset management products.

For the asset management component of this segment, we reported revenues of $533 million, our highest level ever, up 45% year-over-year and up 14% from last quarter's record level. We ended the quarter with a record level of assets under management, $282 billion, up 3% from last period.

In Private Investment Management, which encompasses our high net worth client distribution business, we realized revenues of $299 million, up 10% from the year-ago period, but down 10% from the last quarter, as higher volatility and credit concerns caused our clients to become less active in Fixed Income related products. As these results illustrate, our Investment Management segment continues to grow, accounting for a larger proportion and a more stable source of revenues for the firm.

Now, let me briefly review our non-US results. For the quarter, our non-US revenues were approximately $2.7 billion, up versus both benchmark periods. This marks our highest level of revenues from outside the US and non-US revenues accounted for 62% of our Firmwide revenues for the period.

In Europe and the Middle East, we posted revenues of approximately $1.6 billion, up 38% year-over-year, and up 7% from the sequential period. Our improvement from the year-ago period in European Equities Capital Markets was driven, in part, by strong performances in execution services and in derivatives, as we continued to increase our overall market share in these businesses and benefited from a higher volatility.

Our Investment Banking revenues in Europe increased year-over-year, but declined from last quarter's record level. This improvement is due to our best quarter ever in M&A, and higher equity origination activity, partially offset by lower debt origination activity.

Revenues in Investment Management in Europe increased year-over-year, driven in part by our alternatives business. These gains were partially offset by weaker results and fixed income from the year-ago period, most notably in securitized products and credit, consistent with the negative tone in these markets.

In Asia Pacific, we posted record revenues of approximately $1.1 billion, up significantly versus both benchmark periods.

In the Asia capital markets, we posted record results in equities, driven by strong performances in execution services and derivatives, and due to strong customer flow activity as the Asian equity markets continue to outperform other regions. We also posted strong results in Fixed Income, driven by securitized products, real estate, high yield and infrastructure investments.

Our Investment Banking revenues in Asia were higher versus both comparable periods as we completed three IPOs over the course of the quarter, and we are advising on the largest buyout transaction in Japan this year, Permira's purchase of Arysta LifeScience.

Moving briefly to expenses, for the quarter we posted a compensation revenue ratio of 49.3%, a level consistent with the ratio we realized in 2006, and for the first nine months of this year. Over the period our headcount declined slightly, and this decrease was attributable to the restructuring of our global mortgage origination business.

For the quarter, our non-personnel expenses totaled $996 million, up approximately 2% from last quarter's level with higher technology and communications and brokerage and clearance expenses, partly offset by lower professional fees for the period.

Overall, the increase in our non-personnel expenses reflects the ongoing investment in our business as we continue to grow scale around the world. Taking all of this into account, we reported a pre-tax margin of 28% for the quarter, equal to the sequential period.

Our effective tax rate was 27.9%, reflecting the large pre-tax contribution from outside the US Our return on equity for the quarter was 16.6% and our return on tangible equity is 20.6%.

Again, we consider these to be respectable results given the stressed market environment and a demonstration of the benefits we are deriving from our larger scale on our diversification.

Now let me make a few comments about our balance sheet. We ended the quarter with total stockholders equity of approximately $22.5 billion past, we have stabilized, and our long-term capital rose to $146 billion. Over the course of the quarter, we repurchased 5.3 million shares at an average price of $62.43 per share, bringing our full year buybacks to a total of 43 million shares.

Book value per share increased to $39.45, up 3% during the period and a 16% increase for the full year, so right in line with our historical book value compound annual growth rate over time.

We ended the quarter with a net leverage ratio of approximately 16.1 times in line with last quarter, and our average historical simulation value at risk increased to $124 million in the current period reflecting higher volatility in interest rates and equities and greater correlations over the period.

Next, I’d like to review our liquidity position which continues to be very strong. As we’ve discussed with you in the past, we structured our liquidity framework to cover our funding commitments and cash outflows for a 12-month period without raising new cash in the unsecured market or selling assets outside of our liquidity pool.

Our holding company liquidity pool, which is invested in cash and liquid assets, was $35 billion at the end of the quarter. This does not include the significant additional liquidity pool at our regulated banks and broker dealers. This corresponds to a cash capital surplus at the holding company of $8 billion, which is the excess of long-term funding sources over our long-term funding requirements.

In addition, these measures exclude unencumbered collateral of over $50 billion available to the holding company and an additional over $50 billion in our regulated banks and broker dealers. Furthermore, we have seen no reduction in access to secured funding in the repo markets.

We continue to face little refinancing pressures with limited amounts of debt maturing in the near-term. We consider our liquidity framework to be a competitive advantage in today's markets, which effectively positions us to support our clients and to take advantage of various market opportunities.

Before we move on to our year-end summary and outlook, I wanted to bring you up-to-date on some of our larger balance sheet exposures at the end of the period. At quarter-end, we had non-investment grade contingent acquisition facilities of approximately $9.8 billion, down from $27 billion at the end of the third quarter and from $44 billion at the end of the second quarter.

The decline in our commitments is the result of deals being completed and sold in the market, and some deals being closed, but still in the process of being syndicated. Our $9.8 billion of commitments at the end of the period is spread over 16 transactions, so there is a lot of diversification within this book.

In terms of our mortgage inventory at year-end, this totaled $91 billion, reflecting in part the decline in securitization activity over the period. Of this, $12 billion reflects those amounts we have sold to third parties, but have to gross up under FAS 140, and we are not at risk for. The remaining $79 billion is roughly evenly split between residential mortgage-related inventory and commercial mortgage related inventory.

Within the residential mortgage piece, our sub-prime balance sheet exposure amounted to $5.3 billion, compared to $6.3 billion last quarter. This $5.3 billion sub-prime breakdown is as follows: $3.2 billion of home loans, $1.9 billion of investment grade securities, and about $160 million of non-investment grade securities and residuals.

In addition, we had approximately $1 billion of ABS CDOs on the balance sheet at quarter-end. And after consideration of hedges, we remained modestly net short in the ABS CDO asset class.

In commercial mortgages and CMBS, the bulk of this product is a floating rate, with an average term of two to three years. The CMBS component, the vast majority is AAA-rated. It is important to note that this is a regionally diversified portfolio with about half of the commercial mortgages in the US and the other half in Europe and Asia.

In terms of other exposures, we have largely mitigated our risks. We do not own or sponsor any SIVs. And in the asset-backed commercial paper market, we generally participate as an agent only. Our net exposure to monolines after hedges and credit reserves is minimal. And in terms of counterparty credit exposure, over 95% of our exposure is to investment grade entities.

So, although we have not emerged unscathed from the recent market turmoil, we believe we have done a good job in managing our risks, which has enabled us to post solid returns.

As you would expect, in the current environment, our level 3 assets had somewhat increased over the period. At the end of the quarter, we estimate that approximately 13% of our inventory will be classified as level 3 under the FAS 157 GAAP hierarchy. The increase in last quarter was primarily in mortgages and was private equity related.

So we have given a lot of detail on these exposures, but we thought it was important to bring you up-to-date on all of this, given the recent turmoil in the marketplace.

Let me now turn the call over to Erin to provide some color on how we are thinking about what we have accomplished this year and our outlook for 2008. Erin?

Erin Callan

Thank you, Chris. I’d like to take a step back for a moment and make some comments about our full-year results for the firm. Despite all the pressures in the latter half of this year, our 2007 net revenues were a record $19.3 billion, representing a 10% increase over our prior record last year, and this is the fifth consecutive year that we have posted record revenues.

Net income and EPS for '07 were at all time highs of $4.2 billion and $7.26 per share, up 5% and 7% respectively from the prior year on the basis, as Chris discussed, of a record first half and the successful navigation of the difficult market conditions we saw in the second half. Our pre-tax margin for the year held in at 31.2%, while we posted a full year return on equity of 20.8% and return on tangible equity of 25.7%.

All things considered, we're pleased with this performance, especially since these results were a clear demonstration of the diversification we have achieved and worked so hard for over the past several years.

And the point is that each of our three business segments and both Europe and Asia generated record revenues for the full year 2007. Also, our non-US operations accounted for 50% of net revenue, an all-time high.

This momentum extends to each of our business segments and regions, as we continue to focus on expanding our footprint. Our business is ultimately driven by our people, and we ended the year with the headcount of approximately 28,600, which is up over 10% year-over-year.

This gives us significantly more capacity to sustain our growth by expanding our global client base, while also increasing wallet share with existing clients, and particularly given other balance sheet constrains and risk management issues at a number of our peers.

In investment banking, we've made substantial strides, as evidenced by our higher quarterly revenue run rate. Our volume of M&A completions increased 64% year-over-year and announcements for the '07 calendar year were up approximately 41%. Of our announced M&A, over 40% of the volume for the year represented cross-border transactions, which is a trend. We'll talk about the fact that we continue to expect this to be in full force for '08.

We have increased our share in IPOs. And year-to-date, we're the top underwriter of US IPOs by market share. The breadth of our investment banking franchise has increased dramatically, as evidenced by our completion of approximately a 100 transactions with revenues in excess of $10 million this year. This is almost double last year's tally of large size transactions, so a great progress.

Geographically, we have added significant scale in Asia. We've made key appointments in Europe. And most recently, we extended our presence into India, Canada, Australia, Brazil, Russia and the Middle East, all markets that we consider to be critically important. We've received important mandates in virtually all of these markets, already in the 2007 fiscal year.

Despite the more difficult market environment, we have continued to make progress in capital markets, as demonstrated by our increased market share in many products, our top rankings in surveys that evaluate overall quality and trading, sales, and research capabilities around the globe. Importantly, in 2007, it was also about thoughtful risk management and capital and resource allocation.

We are positioned for growth in capital markets, which is a truly global story, with 69% of our equity revenues and 56% of our fixed income revenues in 2007 sourced outside the United States; in Europe and Asia. We've attempted to solidify these gains in our international capital markets franchise, both through organic growth that we have discussed and also through acquisition.

In 2007, we made purchases of Grange Securities in Australia, MNG in Turkey, and Brics in India. We've continued to build our capabilities in a number of products, including derivatives, prime services, commodities and foreign exchange. These businesses have become and continue to be ever more important components of our revenue growth.

In investment management, we continue to focus on building out the platform globally, and our growth in assets under management has been largely from net inflows, on the basis and on the back of strong performance.

We've continued to expand our product offerings. For example, our private equity assets under management increased by 60% this year, as a result of new private equity funds launched in 2007.

Alternative investments: The focus of the firm is currently representing 12% of our year-end assets under management, and we are looking to grow this proportion further over time. In 2007, we also grew this segment through the acquisition of HA Schupf, LightPoint and Dartmouth Capital, and the acquisition of minority stakes in a number of hedge fund managers, including DE Shaw and Spinnaker.

So even with the challenges over the last six months, we continue to identify numerous opportunities to drive future growth in the franchise. Despite all of these positive developments in our franchise over the past year, and our relative resilience in navigating these markets, we do expect the near-term market environment to continue to be choppy. So we remain cautious, but constructive, and feel very good about Lehman's competitive position going into 2008.

There are still numerous headwinds that pose challenges to both the economy and the capital markets that most of us are quite familiar with: ongoing problems in US housing and mortgage markets, high oil and commodity prices, constrained bank balance sheet, dislocations in the inter-bank lending market, and the need for further resolution around the SIVs and monoline capital.

Our Lehman strategists regard the outcomes as almost binomial in nature, ranging from most likely slower economic growth to the possibility of a recession. The global economy continues to reverberate from two shocks; problems in the US housing market and the capital markets' liquidity squeeze.

As a result, we have made some downward revisions to our projections on global economic growth. Our outlook is for global GDP growth to be 2.7% in 2008, and we've lowered our US forecast to 0.4% in Q4 and 1.8% for the full year 2008.

However, and as we have seen this as recently at the past 24 hours, we expect central banks to be proactive in promoting positive economic growth whether to rate cuts or providing additional liquidity to the system during the period of financial market stress. We have seen these recent actions by the Fed, the Bank of Canada, the Bank of England, the ECB and we are seeing collaboration amongst those parties.

Our global growth assumptions also underpin our view in Investment Banking activity, going forward. We do expect announced M&A volumes to decline approximately 20% in 2008, which is in line with 2006 levels. Strategic buyers concurrently comprise about three quarters of M&A activity, and will account for a larger proportion of overall deal volume. We expect stock to become a more prominent form of consideration versus cash in these transactions.

Given the changes we have seen in cross currency rates and current trade and balances, we also expect cross-border M&A and international activity to increase. As we noted before, it was 40% of our announced volume for 2007, and we expect that to go up in ’08.

Higher equity market volatility will most likely cut equity issuance to be down in the near-term, as we have seen a number of IPO's post from the market over the last several weeks. However, we are expecting a significant amount of hybrid capitals come-to-market in the coming months, as financials increasingly address quickly their balance sheet issues and raise capital. And this is a trend we continue to expect to see for the foreseeable future.

Lehman is the market leader in this product. We are incredibly well-positioned for this opportunity. For example, the last month we lead managed transactions for Freddie Mac, Fannie Mae, and Washington Mutual are advising Warburg Pincus on their investment in MBIA.

We still expect fixed income origination to grow to approximately $10 trillion for the full year '07 although we are forecasting an 8% decline to $9.2 trillion for 2008, due to lower component of securizations in M&A financing. Despite credit spread widening, absolute rates for high grade borrowers who borrow on a fixed rate basis have changed little, due to rallies in treasuries. We are starting to see issuance pick up heading into the New Year.

We are also seeing large numbers of borrowers turn out commercial paper given the shape of the credit curve and the attractiveness of doing so. Fortunately the new business, we are seeing in M&A and in debt underwriting is generally high margin business, which should help offset lower volumes. The other phenomenon, which is helping to bolster Investment Banking, is nontraditional business, primarily through derivative risk solutions for our corporate client. This has become an even more meaningful contributor to Investment Banking revenues.

In the Equity Capital Markets, we expect the 2008 return of 13% in local currency terms, while projecting corporate earnings globally to increase 2%, but declining 5% in the US. Equity valuations remained attractive, even after adjusting for higher risk premiums, which should bolster market activity. Given what the markets have been through recently, we expect active risk mitigation strategies to continue to be important tools for institutional investors globally.

Fixed Income Capital Markets will continue to face uncertainties over the near-term, as some products remain impaired, while others will need to trade at the [stressed] prices to clear bank balance sheet. Fortunately, we are starting to see the stress investment pools established initially in the leveraged loan space about $30 billion in the past few days alone and increasingly in the asset-backed space. Although risk aversion had prevailed in recent weeks, I would note that fixed income investors cannot stay on the sidelines for extended periods of time, due to the inherent cash accumulation in portfolios from regular interest payments and maturities.

In the US alone, we estimate approximately $3.1 trillion of cash is coming, due to investors in 2008, from interest payments and redemptions. A further recalibration of risk and reward has brought corporate, securitized and mortgage credit, back to their cheapest levels in the current decade, a fact alone that will attract investors over time. In general, we expect customer activity to be strong with significant portfolio reallocations and rebalances occurring to take advantage of the opportunities that exist.

We also expect volatility to remain at these higher levels, and this is beneficial for a number of our businesses, particularly in derivatives. In addition, higher volatility as well as wider bid [ask] spreads and a more normalized yield curve provides more profitable trading opportunities in the secondary markets for the firm. Given the strength of our customer franchise, we expect our capital markets revenue-base to benefit from this trading opportunity, going forward. In general as we've indicated we have come through the current downturn very well-positioned on a competitive basis.

We believe we can capitalize on this opportunity for 2008. The consistency of Lehman's senior management team, and the strength of our brand and reputation, are reassuring to our clients, and have already let in recent significant mandates for the firm. Conservatively, our view right now is that the asset prices in the fixed income market will begin to stabilize over the next six months, which will serve as an inflection point for improvement in fixed income, later in the 2008 calendar year.

By growing the franchise in 2007, we've realized some positive offsets that have helped to mitigate the effects of the fixed income downturn. We've made great strides in the commodity space, global rates business, and emerging markets. Our investments in banking, equities, investment management, and outside the US have been paying back, such that we have been able to mitigate the severe impact of a significantly lower mortgage business run-rate all year.

Let me conclude by noting, that this was an extremely challenging period in the global markets. Although we were clearly impacted, we were able to navigate these markets relatively successfully and post a reasonable financial performance. We would attribute this success to our better business mix and geographic mix today, as well as our strong risk and liquidity management. We believe the current markets will present us with a significant number of client and trading opportunities, as a result of the market dislocations. 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 business over the long-term.

Before I turn it over to Q&A, I just want to make one point. I want to say thank you to Shaun Butler, our Director of Investor Relations. This is Shaun's 56th earning call for Lehman Brothers and she is retiring in the early part of next year. So on behalf of the firm and I am sure many people on this phone call, I just want to say thanks for all of her great work.

Now, Chris and I will be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Guy Moszkowski, you may ask your question and please state your company name.

Guy Moszkowski - Merrill Lynch

Good morning. Thank you. I am with Merrill Lynch. Before I get started, let me second the motion on Shaun and tell you how much I think we'll all miss you.

Now to business. I was wondering if you could give us a little bit more color around the basis risk issues that you've talked about, which reduced hedge effectiveness in the quarter. Which areas were most affected, just an idea of what it was that happened that caused that kind of breakage?

Chris O'Meara

Okay. Well, Guy, as we saw in this quarter, the credit spread widening extended out, it really affected more products this time and went up the capital structure. So, we saw the big credit spread widening in Alt-A products, in prime products and in CMBS type products, which is really more of a supply demand imbalance, we think, than anything else.

But some of that -- we talk about having a hedging program. We have a hedging program that might not be at the same parts of the capital structure, there might be some geared hedging and it's across various different types of hedging products. So, we thought about ABX which is a product we use as hedging. We use total return swaps on home-equity loans, the Lehman Bond Index, overall. Some single name CDS on individual traunches of securitized product. And it just didn't all work in the same direction. So, there are two things going on, one is that the notionals may not be fully hedged, and the second thing is and I think you've heard a little bit around certain other hedging strategies around the street, is the correlations didn't necessarily work between the cash products and the index products in a precise way. So, that led to the breakage that we talked about.

Guy Moszkowski - Merrill Lynch

Great, thanks. Let me follow-up with a question on the margin impact of moving to sort of a more plain-vanilla environment which you alluded to? As we think about next year, and the fact that type of environment could persist for while. How should we think about the margin in your Fixed Income trading areas evolving relative to what we saw the last couple of years when more exotic products were more in favor? What kind of margin stepped down, that makes sense to think about in the more plain-vanilla environment?

Chris O'Meara

Certainly, we would expect a pullback in the amount of securitize product volume that's going to run through, particularly on the origination side. So, new issue, we would expect to come down pretty significantly, for some period of time. The good news though is, that this shifts from being an origination opportunity to a secondary trading opportunity. So, our thought is that, when the market reaches equilibrium the activities will pickup, and there will be lots of secondary trading opportunities for us to help transition our clients who want to move in and out of these products, and also for us as a risk taker on this. So, when you think about what the margin decrease would be, certainly, it would be significant on the primary side, but we think at least part of that we'll made up on the secondary side. And as we look out, we talk about this $830 million of write-down that we experienced in this period from the significant credit spread widening, certainly, we wouldn't expect that to recur and we're sort of trying to give information around where we think the revenue generation rate is of that fixed income business as we look forward, if you exclude that $830 million of write-downs.

Erin Callan

And just to elaborate on that, Guy. I don't think we see there to be real margin compression as we look out in '08 around the Fixed Income business, secondary volume should go up. I think as we talked about in the past, the formation of capital to take advantage of the stressed opportunities in the securitized product space is taking longer than in the leverage loan space which is exactly what we anticipated, given the need to migrate the intellectual capital around that business away from the street to the buy side. But we are starting to see that happen, funds are popping up here and there and as we get more capital formation there, new secondary trading opportunities will really come through for us and we are well positioned with the in-house expertise and with the reputation in the asset class to do well there. So, I don't think we're looking at that as something that's going to bring us into some margin compression in Fixed Income.

Guy Moszkowski - Merrill Lynch

And does it make sense to think about those pools of capital forming around the asset-backed areas, as essentially stalled until it becomes clearer what the interruption to the underlying cash flows of the instruments like subprime mortgages looks like?

Erin Callan

Yeah, I think that is a fair comment. We sort of need more information fundamentally on the underlying, to have the confidence for people to really step in there, and I think that's a lot easier to do in the leverage loan asset class and it is around in these products. But those relationships, certainly, between, say the ABX and the fundamentals of those underlying assets, need to stabilize a bit.

Guy Moszkowski - Merrill Lynch

Thanks. And then, I have a final question on VaR Calculation. I think in general, VaR is defined as applying to liquid assets. As assets migrate to level 3, which we have seen a lot of in the last couple of quarters and you alluded to again today, is there some potential that some of those assets fall out of the historical VaR calculation because they are no longer liquid? In other words, is there potential for VaR to be understated now because of some kind of survivorship bias issue?

Chris O'Meara

We don't treat that that way, Guy. We put them in the VaR calculation whether they are in level 3 or level 2. Anything that was in there that's a traded product we do put in there even if the trading markets have become opaque.

Guy Moszkowski - Merrill Lynch

Okay, that's great. Thank you very much.

Chris O'Meara

Yes.

Operator

Mike Mayo, you may ask your question and please state your company name.

Mike Mayo - Deutsche Bank

It's Mike Mayo with Deutsche Bank. Can you elaborate more on the $3.5 billion of gross charges; you said $2.2 billion in residential mortgages. How much of that was for subprime and what was the rest for?

Chris O'Meara

It was across the different categories, Mike. So, subprime was certainly a component of it, but it was, just looking at the component pieces, it was from prime, from other asset categories including student loans, there was credit spread lightening that we saw in Europe, as well. So, it's spread out. So, the $2.2 billion is across the entirety of it.

The biggest other category and this is really limited to the securitized products business and the real estate business and the CDO that we mentioned, the biggest piece would be real estate, so the commercial mortgage, we call it real estate, but the commercial mortgage business also saw credit spread widening both in the US and in Europe.

So, it's in those categories and then, of course, CDOs experienced a significant decline as well, we're not digging it, but to the extent that we are in it there was significant adjustment, that was taken as well.

Mike Mayo - Deutsche Bank

I guess where I'm going with this is, you don't expect the $830 million of net charges to reoccur, but you had $700 million last quarter net and prior to anything that would reoccur either, conditions can get worse. So the question really is, how much have you written down your exposures in leveraged loans for that $10 billion, how much of that has been written down. In terms of the subprime the $5.3 billion, how much of that has been written down. In terms of the CDOs, the $1 billion, how much of that has been written down?

Chris O'Meara

Okay. Let's just go in order, you just said. The leveraged loans we talked about, last time we had $27 billion of contingent facilities that was marked at the end of August. It represented in that period, the third quarter a significant markdown. So, third quarter exited August with those positions markdown. We then had a bump back-up, we sold a lot of those positions, realized gains, the ones that weren't sold are, as part of their general credit spread widening that took place in November. Those have been marked appropriately and you can see in the indexed based information that high-yield credit spreads are wider now than they were in August. And so wider at the end of November, than they were in August, and so you would see those credit spread widening or the market valuation of that credit spread widening applied to whatever positions that we have remaining in the high yield space.

Mike Mayo - Deutsche Bank

So on average, have those been written-down by, say, 4% or 5%?

Chris O'Meara

Not from August 31, but yeah from -- I don't want to get into it, Mike, because as you look at the individual items, every situation is different. Each one has multiple parts of the capital structure that are in the capital raise, and so each one is different. So I'd rather not give specifics on what it is. But the math can be done by looking at the high yield market industries of both the LCDX and other high yield indices.

Mike Mayo - Deutsche Bank

And then the $5.3 billion subprime?

Chris O'Meara

We started out the period with $6.3 million, as we mentioned. That $5.3 million that's here now is not the same as the $6.3 million that was here at the beginning of the period. Much of it is the same because there has been a slowdown in activity, but we have had sales of whole loans. We have done the couple of securitizations and sold out senior pieces, not junior pieces. And then we've written-down some things, we've taken on some positions.

But we've had significant write-downs percentage wise, but that is a manageable number for us, the $5.3, and much of that, as we mentioned, the non-investment grade portion albeit less meaningful than it was at that terminology with non-investment grade, less meaningful than it was at times in the past. The non-investment grade piece and residuals is $160 million. That has been written down quite significantly.

Erin Callan

Mike, this is Erin. I want to make one broader comment to make sure that we are clear on this. We are not suggesting this is a one-off and we're not going to see any further valuation reductions in these assets in the market.

I think, our full expectation is, as I discussed earlier, that asset repricing to the downside could continue for the better part of the first two quarters of next year. So, we are trying not to be too optimistic. Let's say that this is the bottom and we're now calling the bottom.

But our job is to make sure, we're not too concentrated in our risks around any one asset class and to make sure we've affected as best of risk mitigation strategy as we can.

So we're not calling the bottom here, we're not suggesting that there aren't going to be further reductions. I think what we're suggesting is, we continue to hopefully do a good job in diversifying our risk, staying with the highest quality parts of these asset classes and also to focus fully on how we can enhance our risk mitigation to deal with that type of an environment.

Mike Mayo - Deutsche Bank

And then just lastly then, your CMBS exposure, how much is that? And what was the change during the quarter?

Chris O'Meara

Well it's about, when you say CMBS exposure, the CMBS balance sheet is about, as we said, about half of the $79 billion of risk assets on the balance sheet that's in the mortgage and related category. So, call it about $40 billion, spread out all over the world that was written down. We did have some realized gains in Asia, not in the other categories, but that has been written down in a significant way, that's included in the 3.5.

Mike Mayo - Deutsche Bank

I'm sorry, how much of those charges were for CMBS?

Chris O'Meara

CMBS versus whole loans? Much of what we have in there is whole loans. The reason a lot of it goes into Level 3 GAAP hierarchy category under the fair value is because these are unique assets, these big commercial properties. And you don't have good price discovery for those same types of assets. And so we put them in Level 3, much of our whole loans on average there maybe 70% LTV, loan-to-value ratio, but yes, with the credit spread widening those have had a reduction in value.

Mike Mayo - Deutsche Bank

I’m sorry, just one more. How much of the charges were for CMBS specifically? How much for CMBS written debt?

Chris O'Meara

Mike, we are not giving that, but it’s a significant portion of the difference between the 2.2 and 3.5.

Mike Mayo - Deutsche Bank

Okay. Thank you.

Chris O'Meara

Okay.

Operator

Our next question comes from Meredith Whitney. You may ask you question and please state you company name.

Meredith Whitney - CIBC

Meredith Whitney, CIBC. I have got a few unrelated questions. On the GLG gain, can you walk us through how you get from the $480 million down to a net number? And then, in terms of similar type of transactions that at this point in time you can see throughout 2008, can you quantify another in number of transactions or value of transactions in terms of D.E. Shaw, not officially in the pipeline, but looks likely to be in the pipeline? And then lastly, where do the Freddie revenues flow through -- the Freddie deal revenues flow through, please?

Chris O'Meara

Okay. The Freddie deal revenues flow through the Investment Banking segment. On the GLG, can you repeat the GLG question?

Meredith Whitney - CIBC

The first question is about getting into a net, that wasn't clear to us.

Erin Callan

Yes, but could you -- we have the revenues, but can we get to a net number?

Chris O'Meara

Well it's --.

Erin Callan

How it flow through down to net?

Chris O'Meara

We think about it as being part of the overall revenue generation in the Firm. We don’t really think about it as being a net item. It's one of the items that are in the Equities Capital Markets segment. It’s a lumpy item. We do have other private equity investments that will be generating revenue. We’ve seen pretty consistent, when I say consistent meaning, if you look at our four-quarter rolling average, for example, you would see something like $75 million to $100 million of revenues that's coming through from our private equity investments generally. So, this aggregate of $500 million does represent a lumpy item that's in there that is because of the GLG transaction that was executed.

Erin Callan

And one point of clarity Meredith, it's Erin, is just to be clear about our stakes in hedge fund managers, on the whole that portfolio, which is now a nice diversified portfolio of managers, is really intended to be an earnings tool. We do not enter into those transactions with the goal of an exit at the backend. Certainly GLG turned out very nicely in that sense, but these produce great returns on our equity investment when we are dealing with really strong managers that we have invested in. And so, we are not looking at a pipeline of those managers to suggest realization events over time. We are investing in those managers, because they have a lot of synergies with our business. They produce great returns on equity for the Firm. And that's how we are thinking about those going forward.

Meredith Whitney - CIBC

Erin, I totally understand and I appreciate that you guys have articulated that strategy, but given the fact that you are an expert in that field, there are a lot of deals in the work for 2008, many of them that we know, many of them we don't know. Of your exposure to those, how many are in discussions for a '08 filing?

Erin Callan

Obviously, that would be information, especially in my current role and in my prior role that we couldn't possibly divulge in consistent with Securities Laws violations.

Meredith Whitney - CIBC

I wasn't asking for a name, just generally, right?

Erin Callan

We only have about six to seven names or so. It would sort of identify, based on the size of those clients. Anything could happen, obviously, the environment has been good for managers to come to market. So, is that a possibility for any good, strong well diversified, long-standing hedge fund managers? Yes. Are there many, many who are not going down that path for lots of cultural reasons? Yes. So, I really can't comment on that.

Meredith Whitney - CIBC

All right. Thank you.

Operator

Glenn Schorr, you may ask your question and please state your company name.

Glenn Schorr - UBS

UBS. Thanks. How about just a simple one? How come the balance sheet or your net assets keep going up? I know there is not a heck a lot of liquidity out there, but if originations slow, wouldn't the goal be to kind of digest and shrink, if you could, or at least bring in leverage a little bit?

Chris O'Meara

Well, we are certainly mindful of what's happening there, Glenn. As we build our equity base, we are rolling our firm. So as we build our equity base even through periods of stress, you look at how much equity we've actually generated and held in the organization, as capital continues to grow our business.

So we are growing our business, and we continue to develop it outside the US, particularly as we've talked about in Asia and the different countries around Asia. We've continued to pour fuel in there, both in terms of headcount resources and also in financial resources to run the businesses. So we're continuing in growth mode.

Erin Callan

Also, I guess I would say, Glenn, that as we identified, we are flat on our net leverage ratio, quarter-over-quarter. And this environment is the perfect opportunity for us to take ground from our competitors, with our clients. So, the fact that we continue to make our balance sheet accessible for client business is crucial to how we are thinking about moving forward into 2008.

And so, I think pulling back when we are comfortable with the leverage ratios we have, the growth of our book value per share, the growth of our long-term capital base would actually be a pretty critical strategic mistake for us, since we have this moment of opportunity to really make ourselves available to our clients.

Glenn Schorr - UBS

Thanks. I guess a fair enough point, given the job is done on the hedging side. Maybe that leads to the next question. You alluded to the basis risk and the effectiveness of certain hedges breaking down in a weird month, like November. Is there any point where we have to start getting worried about the effectiveness of hedges and have you ever unwind?

In other words, if there is ever that equilibrium point that we all pray for that you mentioned earlier that secondary trading gets better because they have spreads on the less liquid stuff gets more liquid? How do you get out of those hedges?

Chris O'Meara

Yes, that's a good concern. I do think that’s something that is important to keep focused on. We do have the hedges when you talk about the hedges, but hedges are with individual counterparties as a CDS is with a particular counterparty. And so, it's a bilateral agreement that you are going to negotiate to workout of.

A lot of these hedges are life of trade hedges. But your point, if you do get into a place where the market stabilizes and there is a movement in these assets, you are going to dynamically try to reposition your hedges and work with the counterparties to move out. And I don't think it’s going to be.

I do think, in terms of the ABX, is one that has been very, very active, and so that's one that seems to get oversold just because there is more hedging. People who want hedges, use the ABX. But on these other ones, there is, as I mentioned, lots of different indexes that you can point to the set hedges, but they are bilateral hedges and you are going to work with those counterparties to move out of them.

Glenn Schorr - UBS

Okay. The point of clarification on your level 3 comments at 13%, if I remember correctly, that's up from around 12% if your fair value positions went up in line with your net assets. That means level 3 assets went up a couple of billion from last quarter. Is that about right?

Chris O'Meara

I think it was about 11, Glenn, so 11 to 13 is yes. It’s a few billion, maybe $6 billion.

Glenn Schorr - UBS

Yes. And then, is that stuff moving in from level 2, similar to last quarter, less liquidity or is there some --?

Erin Callan

Some of that.

Chris O'Meara

Yes. There are lots of things going on. But some of it is transferring in from level 2. But there are purchases that are in there, the purchases are bigger than the transfers.

Glenn Schorr - UBS

Got you. And then, I think we all assume that things related to CDO and subprime, and you made your comment about commercial real-estate consume up most of the write-downs. But I don't know, if you want to talk about maybe what cum losses you lose using in your mouth, or we'll take it, if you want to tell us what piece of the write-downs were things other than subprime and CDOs, meaning we really want to get through Alt-A prime, anything else.

Chris O'Meara

Yes. They are certainly in there and significantly Alt-A across the capital structure. Each of these, in terms of how these market values are established, at the top of the capital structure, particularly on AAA, in both prime and subprime, there is market discovery. So there are transactions being executed in the AAA space.

As you move down the capital structure, there are transactions being executed. Maybe there are some, but it's not as visible and there’s not as much information on it. And so, the way to model them out is, you have to default to the information that is visible, which is the index trading around ABX in the different parts of the capital structure for ABX.

And so those inputs or that information around the ABX is used to price out the cash products in the bottom parts of the capital structure. But there are some trades being done. We've got good visibility into them. There are many of them that are being done, because we are around them. We are either participating in them or we are having a look at them for the most part. And so, we do have intelligence around the pricing information for these instruments.

Erin Callan

And I think one just thinking about that and below the AAA part of the cap structure -- I mean obviously the ABX is transparent in terms of its inputs and HPA assumptions. So take a look at that and give you some good guidance as to what the cumulative loss assumptions are.

Chris O'Meara

And when I am talking about the intelligence, I am talking about first derivatives, meaning securitized products, not the second and third derivatives, CDOs and CDO squares, which are more opaque obviously.

Glenn Schorr - UBS

I am with you. How about last quickies? Is the 3.5 and 2.2, any chance you share the year-to-date numbers with us?

Chris O'Meara

Well, I think last time, we talked about the leverage loans being down well over $1 billion. But I don't think we talked about our mortgage assets last time, but that was also well over $1 billion in the third quarter. So, think about that as a couple of billion more than what we have here in the back half of the year.

In the first half of the year, it's not something that we track. And even though there were write-downs in the subprime products in the second quarter, maybe at the end of the first quarter, it's less significant.

Erin Callan+

Yes, so kind of five to six range growth is a reasonable approach.

Glenn Schorr - UBS

All right, okay. Thank you all.

Chris O'Meara

See you, Glenn.

Glenn Schorr - UBS

Right.

Operator

William Tanona, you may ask your questions and please state your company name.

William Tanona - Goldman Sachs

Hi, Goldman Sachs. Hi, Chris. Hi, Erin.

Erin Callan

Hi.

William Tanona - Goldman Sachs

Could we focus a little bit on the monolines? You had mentioned in your kind of commentary there that you do have some exposure to the monolines and you have that fully hedged. Could you let us know how much exposure you have to all the monolines outstanding?

And I guess the second part of the question would relate to how do you guys hedge that type of exposure specifically?

Chris O'Meara

Okay. Two pieces on it, when we said -- my comments were either hedged or have credit reserves to make the exposure minimal. So, we do have exposure to monolines. There are a number of different players in the industry where we have bought protection and in some cases that protection will be reliable and in some cases it won't be. We've evaluated that and we have set up hedges on the credit worthiness of those enterprises in the CDS market. So, these, their credit defaults swap straight in the CDS market or many of them do and have and we have bought CDS protection on many of them and in some cases, we've just made conclusions that, we don't -- won't be necessarily able to count on certain counterparties and so we've set up reserves appropriately.

Erin Callan

Yes, I think, William, if there is a reasonable amount that is actually we would look at sort of money in our favor actually, in terms of the monoline exposures that we have and as Chris pointed out, we've been aggressive about taking reserves on that and basically assuming that, there will be a little performance there. So, it's a pretty positive story for us.

William Tanona - Goldman Sachs

So, just so I understand that, it’s, I guess I was wondering whether there would be timing differentials, given what's happened to a lot of these publicly traded monolines and their spreads that if you are using those type of products to hedge yourself that you would booking these type of gains today. And if they were to ever run into issues you had be downgraded or that exposure would have come back to you, that you would have to pick those losses at a later date? But it sounds like what you're doing is, picking those gains but also reserving…

Erin Callan

Yes.

William Tanona - Goldman Sachs

For those incidences?

Erin Callan

Exactly, and just to be clear, it's actually a pretty small handful of transactions in terms of this exposure for us as a Firm, which is, obviously not going to be quite the case across the board in the industry, but we are talking about a pretty small number trade.

William Tanona - Goldman Sachs

Okay, that's great. And then the second question, in terms of, listening to your outlook and listening to other people in the marketplace. Obviously, I think there is a little bit more of a cautionary tone around the capital markets here. Just wanted to get a sense as to how you are thinking about the non-comp expenses? Obviously, I know you guys are still growing and that you are looking to grow the business and stuff, but when I look at kind of the year-over-year growth, it still seems pretty high. So, just want to get your thoughts as to how you are thinking about controlling the non-comp expenses as we enter into what may be a little bit of softer patch here?

Erin Callan

Yeah, I think, William, if you look at the 996, Q4 NTE number has really a good run rate to annualize for 2008 something about $1.25 billion on NTE. A lot of the changes in NTE, of course, reflect growing our geographic footprints over the year, a lot related to occupancy as you would expect and a lot related to opening offices in new regions including, we talked about, Turkey, Brazil, expanding India, etcetera. So, roughly up probably 5% or so from the '07 number. It's probably is a '08 projection, but as we try to be countercyclical investors here, we are not talking about a big jump, but we are talking about roughly 5% or so.

Chris O'Meara

Yeah, apart from the run rate in the fourth quarter.

Erin Callan

The run rate in the fourth quarter, yeah.

William Tanona - Goldman Sachs

Okay, great. That was helpful.

Operator

Our last question comes from Douglas Sipkin. You may ask your question and please state your company name.

Douglas Sipkin - Wachovia Securities

Thank you and good morning, Wachovia. Just three questions, a couple of things have been answered. First off, I believe you've provided your prime brokerage accounts at year-end, I think you said 630, I was hoping maybe to get that this time last year November 2006?

Chris O'Meara

About 525.

Douglas Sipkin - Wachovia Securities

525. Thank you. And I believe there were some incremental mortgage charges this quarter for some of the reductions in your origination capacity. I think you'd put that out. Can you give us that number as well?

Chris O'Meara

Yeah, the non-comp piece of that was just north of 15, it was 18 and then the comp piece was absorbed in our 49.3% comp ratio versus revenues. So, as we look forward, those personal adjustments have been taken.

Erin Callan

Yeah, 18 compares to 44 for Q3.

Douglas Sipkin - Wachovia Securities

Okay, that's helpful. And then just finally, I think it was touched down in the previous question about the CDS market. Obviously, you guys have made an effort to build some reserves, not having as much visibility about the counter-parties. How big of an issue do you think this potentially could be, given that we are probably entering a rising loss period where other potential firms, buyers or sellers are maybe relying on counter-parties that might not be able to come through in a loss scenario? Are you concerned at all? Obviously, you guys are thinking about as though you concern that other players in this rapidly growing market are not thinking about it?

Erin Callan

I guess the good news for us, Doug, is that away from the monolines, every other counter-party we do business with post collateral to us, and I think you heard us in the presentation talk about on this, 98% of our counter-parties are investment grade. So, the combination of those two factors, I think, makes us feel comfortable about what it means directly to our exposures to those institutions.

It's very hard to judge and I guess, well, to see it now over the course of next few weeks and next month, how each of the firms are handling this particular issue. So, I think that maybe people are doing it like us, maybe not. It's hard for us to tell.

I think we feel well protected in terms of our interaction and credit exposure to those organizations on posting of collateral and ratings, but it's really hard to judge if there is consistency to how this is being handled across the street.

Chris O'Meara

And in terms of the broader market and what it would mean, I think a lot of it is priced in. So, folks are the capital markets participants, who are pricing that in. But I do think, it would be another doubt of bad news that could be sensationalized and could lead to some more difficulty in the capital markets. But then it will get through it because I do think a lot of it's priced in.

Douglas Sipkin - Wachovia Securities

Okay, great. Thanks for taking my questions.

Chris O'Meara

Okay, see you.

Erin Callan

Okay. So, just want to thank everybody again for joining us today. I want to thank Chris, as he now migrates into his new role as my partner the Head of Risk Management for the Firm. And we look forward to speaking with you next quarter.

Chris O'Meara

Okay. Thanks everybody.

Operator

This does conclude today's conference. Again, you may disconnect at this time. Thank you.

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