Lehman Brothers F4Q07 (Qtr End 11/30/07) Earnings Call Transcript

Dec.13.07 | About: Lehman Brothers (LEH)

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

Executives

Shaun Butler - Director of IR

Chris O'Meara - Global Head of Risk Management and formerCFO

Erin Callan - CFO

Analysts

Guy Moszkowski - Merrill Lynch

Mike Mayo - Deutsche Bank

Meredith Whitney - CIBC

Glenn Schorr - UBS

William Tanona - Goldman Sachs

Douglas Sipkin - WachoviaSecurities

Operator

Good morning and welcome to the Lehman Brothers' FourthQuarter 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 andyear-end update. Before we begin, let me point out that this presentationcontains forward-looking statements. These statements are not guarantees offuture performance. They only represent the firm's current expectations,estimates and projections regarding future events. The firm's actual resultsand financial condition may differ, perhaps materially, from the anticipatedresults and financial condition of any such forward-looking statements.

These forward-looking statements are inherently subject tosignificant business, economics and competitive uncertainties andcontingencies, many of which are difficult to predict and beyond our control.

For more information concerning the risks and other factorsthat could affect the firm's future results and financial conditions, see "RiskFactors" and "Management's Discussion and Analysis of FinancialCondition and Results of Operations" in the Firm's most recent annualreport on Form 10-K, and their quarterly report on Form 10-Q as filed with theSEC.

This presentation contains certain non-GAAP financialmeasures. The information relating to these non-GAAP financial measures can befound under Selected Statistical Information; Reconciliation of AverageStockholders' Equity to Average Tangible Common Stockholders' Equity; and Leverageand Net Leverage Calculations in this morning's earnings press release. Thisrelease has been posted on the firm's website, www.lehman.com. It was also filedwith the SEC in a Form 8-K, available at www.sec.gov.

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

Chris will be reviewing our results for the fourth quarterand will provide an update on certain key exposures of our fiscal year-end. Erin will then discuss some of our key accomplishments in2007, while providing a framework of how we are thinking about our outlookgoing 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 respectableresults this quarter in what became an extremely difficult market environmentas the period unfolded.

Despite the market turmoil during the quarter, we achievedrecord results in both our Equities Capital Markets business and InvestmentManagement segment. Regionally we generated 52% of our revenues this quarteroutside the US,our highest proportion ever. Clearly the strength in these areas helped topartly mitigate the significant dislocations and supply/demand imbalances inparts of the USand European fixed income businesses over much of the period.

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

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

In Fixed Income, US credit spreads hit multiyear wideswith investment grade spreads at their widest level since December 2002, andhigh yield spreads at their widest level since July 2003. As a result, Novemberwas the single worst month on record for US investment-grade corporates andasset-backed securities, tallying negative excess returns ranging from negative300 to 338 basis points.

This dramatic spread is widening, and it lead to Flight toQuality as the two-year treasury rallied over a 100 basis points, and the yieldcurve steepened. The equity markets followed a similar pattern rallying in thefirst half of the period. This was mainly in response to a larger than expectedcut in interest rates, a general feeling that the credit crisis was behind us, asentiment that there would be a soft landing, and the DOW reaching a newall-time high.

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

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

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

We attribute this performance to several factors. From abusiness 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 activitiesversus proprietary as the primary source of revenues, which has helped usmitigate the impact of difficult market environments, as institutional andhigh-net-worth investors remain active. More fundamentally, it reflects thestrength of our risk management culture in terms of managing our overall risk appetite,seeking appropriate risk reward dynamics and exercising diligence around riskmitigation.

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

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

Nevertheless, this represents thesecond highest level of quarterly revenues ever for the M&A advisorybusiness. For the quarter, our volume of completed M&A transactions totaledapproximately $380 billion. We advised on three of the top four deals completedin all of 2007.

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

In Equity Origination, ourrevenues were $210 million, down 6% year-over-year and a decrease of 29% fromlast quarter's level. For the quarter, our volume of Equity Origination totaledapproximately $4.6 billion, down significantly from last quarter's level withconvertibles accounting for a significant part of the decline. Despite aparticularly difficult IPO market, where many transactions were pulled in theperiod, our IPO franchise realized particular success. For the quarter, we rankednumber one in US IPOs, and we had a 13.8% market share as we completedtransactions for Och-Ziff, DuPont Fabros and SandRidge Energy.

Fixed Income origination revenueswere $233 million, down significantly from both benchmark periods. This was dueto the weakness in the leverage loan and high yield markets as the creditspread hit their wide for the year, as was noted earlier. This deterred anumber of high-grade and high-yield borrowers from accessing the markets. Anddespite these pressures, we ended the quarter on a positive note, leading the$6 billion preferred transaction for Freddie Mac, something Erinwill discuss in more detail later on.

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

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

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

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

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

Our principal trading strategieswere also stronger versus both benchmark periods.

Lastly, gains from private equityand our investment in GLG were approximately $500 million, significantly higherthan both comparable periods.

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

This impacted our business inthree major ways. We had negative marks on our Fixed Income inventory. In someinstances, our risk mitigation strategies were less effective as correlationsbroke down, and we incurred a higher degree of basis risks. Heightened riskaversion was among investors, which caused them to shift their trading activityto higher quality and more liquid products, which tend to be less profitablefor the firm.

Now I'll walk you through thevaluation adjustments. For the period, we incurred a net revenue reduction fromposition valuation changes of approximately $830 million in our Fixed IncomeCapital Markets business. Most significantly, this was in residential and commercialmortgage related positions.

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

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

As a result, revenues in ourresidential mortgage business were negative for the period, given thesignificant asset re-pricing that extended across sub-prime, Alt-A and primemortgage product, coupled with declines in both origination and securitizationvolumes.

On a positive note, we postedreasonable results in secondary trading, particularly in synthetics, where weare a major market maker, and Asiasecuritizations, which was less affected by the sub-prime contingent in otherregions.

Results in our Commercial RealEstate business were weaker, due to the spread widening and a lower number ofsecuritizations during the period. However, our results in credit improvedversus last quarter, as the market recovered in September and October, suchthat we were able to realize gains on certain leverage lending positions astransactions closed and distributed, as I mentioned previously.

A number of product areasbenefited from the heightened risk aversion. Consequently, we saw ayear-over-year improvement in liquid markets, including interest rate productsin foreign exchange and commodities. This is also reflective of our largerscale in each of these businesses.

Lastly, while our customer franchiseremained strong, the magnitude of the market dislocations in November causedoverall customer trading activities to slow, and migrate into more liquidproducts. As a result, our sales [price] in Fixed Income dropped approximately20% sequentially, and they were 8% lower than the average for the first threequarters of '07. So clearly, this was one of the most difficult quarters wehave 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 thissegment was $261 million, as we continued to benefit from our expanded presencein higher margin asset management products.

For the asset managementcomponent of this segment, we reported revenues of $533 million, our highestlevel 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, $282billion, up 3% from last period.

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

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

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

Our Investment Banking revenuesin Europe increased year-over-year, butdeclined from last quarter's record level. This improvement is due to our bestquarter ever in M&A, and higher equity origination activity, partiallyoffset by lower debt origination activity.

Revenues in Investment Managementin Europe increased year-over-year, driven inpart by our alternatives business. These gains were partially offset by weakerresults and fixed income from the year-ago period, most notably in securitizedproducts and credit, consistent with the negative tone in these markets.

In Asia Pacific, we posted recordrevenues of approximately $1.1 billion, up significantly versus both benchmarkperiods.

In the Asiacapital markets, we posted record results in equities, driven by strongperformances in execution services and derivatives, and due to strong customerflow 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 revenuesin Asia were higher versus both comparable periods as we completed three IPOsover the course of the quarter, and we are advising on the largest buyouttransaction in Japanthis year, Permira's purchase of Arysta LifeScience.

Moving briefly to expenses, forthe quarter we posted a compensation revenue ratio of 49.3%, a level consistentwith 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 wasattributable to the restructuring of our global mortgage origination business.

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

Overall, the increase in ournon-personnel expenses reflects the ongoing investment in our business as wecontinue to grow scale around the world. Taking all of this into account, wereported a pre-tax margin of 28% for the quarter, equal to the sequentialperiod.

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

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

Now let me make a few commentsabout our balance sheet. We ended the quarter with total stockholders equity ofapproximately $22.5 billion past, we have stabilized, and our long-term capitalrose to $146 billion. Over the course of the quarter, we repurchased 5.3million shares at an average price of $62.43 per share, bringing our full yearbuybacks 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 rightin line with our historical book value compound annual growth rate over time.

We ended the quarter with a netleverage ratio of approximately 16.1 times in line with last quarter, and ouraverage historical simulation value at risk increased to $124 million in thecurrent period reflecting higher volatility in interest rates and equities andgreater correlations over the period.

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

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

In addition, these measuresexclude unencumbered collateral of over $50 billion available to the holdingcompany and an additional over $50 billion in our regulated banks and brokerdealers. Furthermore, we have seen no reduction in access to secured funding inthe repo markets.

We continue to face littlerefinancing pressures with limited amounts of debt maturing in the near-term. Weconsider our liquidity framework to be a competitive advantage in today'smarkets, which effectively positions us to support our clients and to takeadvantage of various market opportunities.

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

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

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

Within the residential mortgagepiece, our sub-prime balance sheet exposure amounted to $5.3 billion, comparedto $6.3 billion last quarter. This $5.3 billion sub-prime breakdown is asfollows: $3.2 billion of home loans, $1.9 billion of investment gradesecurities, and about $160 million of non-investment grade securities andresiduals.

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

In commercial mortgages and CMBS, the bulk of this productis 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 aregionally diversified portfolio with about half of the commercial mortgages inthe US and the other half inEurope and Asia.

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

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

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

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

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

Erin Callan

Thank you, Chris. I’d like to take a step back for a momentand make some comments about our full-year results for the firm. Despite allthe 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, andthis is the fifth consecutive year that we have posted record revenues.

Net income and EPS for '07 were at all time highs of $4.2billion and $7.26 per share, up 5% and 7% respectively from the prior year on thebasis, as Chris discussed, of a record first half and the successful navigationof the difficult market conditions we saw in the second half. Our pre-taxmargin for the year held in at 31.2%, while we posted a full year return onequity 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 thediversification we have achieved and worked so hard for over the past severalyears.

And the point is that each of our three business segmentsand both Europe and Asia generated recordrevenues 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 andregions, as we continue to focus on expanding our footprint. Our business isultimately driven by our people, and we ended the year with the headcount ofapproximately 28,600, which is up over 10% year-over-year.

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

In investment banking, we've made substantial strides, asevidenced by our higher quarterly revenue run rate. Our volume of M&Acompletions increased 64% year-over-year and announcements for the '07 calendaryear were up approximately 41%. Of our announced M&A, over 40% of the volumefor the year represented cross-border transactions, which is a trend. We'lltalk 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'rethe top underwriter of US IPOs by market share. The breadth of our investmentbanking franchise has increased dramatically, as evidenced by our completion ofapproximately a 100 transactions with revenues in excess of $10 million thisyear. This is almost double last year's tally of large size transactions, so agreat 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 becritically important. We've received important mandates in virtually all ofthese markets, already in the 2007 fiscal year.

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

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

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, includingderivatives, prime services, commodities and foreign exchange. These businesseshave become and continue to be ever more important components of our revenuegrowth.

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

We've continued to expand our product offerings. Forexample, 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 currentlyrepresenting 12% of our year-end assets under management, and we are looking togrow this proportion further over time. In 2007, we also grew this segmentthrough the acquisition of HA Schupf, LightPoint and Dartmouth Capital, and theacquisition of minority stakes in a number of hedge fund managers, including DEShaw and Spinnaker.

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

There are still numerous headwinds that pose challenges toboth the economy and the capital markets that most of us are quite familiarwith: ongoing problems in US housing and mortgage markets, high oil andcommodity prices, constrained bank balance sheet, dislocations in the inter-banklending market, and the need for further resolution around the SIVs andmonoline capital.

Our Lehman strategists regard the outcomes as almostbinomial in nature, ranging from most likely slower economic growth to thepossibility of a recession. The global economy continues to reverberate fromtwo shocks; problems in the UShousing market and the capital markets' liquidity squeeze.

As a result, we have made some downward revisions to ourprojections on global economic growth. Our outlook is for global GDP growth tobe 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 24hours, we expect central banks to be proactive in promoting positive economicgrowth whether to rate cuts or providing additional liquidity to the systemduring the period of financial market stress. We have seen these recent actionsby the Fed, the Bank of Canada, the Bank of England, the ECB and we are seeingcollaboration amongst those parties.

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

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

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

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

We still expect fixed income origination to grow toapproximately $10 trillion for the full year '07 although we are forecasting an8% decline to $9.2 trillion for 2008, due to lower component of securizationsin M&A financing. Despite credit spread widening, absolute rates for highgrade borrowers who borrow on a fixed rate basis have changed little, due torallies in treasuries. We are starting to see issuance pick up heading into theNew Year.

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

In the Equity Capital Markets, we expect the 2008 return of13% in local currency terms, while projecting corporate earnings globally toincrease 2%, but declining 5% in the US. Equity valuations remainedattractive, even after adjusting for higher risk premiums, which should bolstermarket activity. Given what the markets have been through recently, we expectactive risk mitigation strategies to continue to be important tools for institutionalinvestors globally.

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

In the USalone, we estimate approximately $3.1 trillion of cash is coming, due toinvestors in 2008, from interest payments and redemptions. A furtherrecalibration of risk and reward has brought corporate, securitized andmortgage credit, back to their cheapest levels in the current decade, a factalone that will attract investors over time. In general, we expect customer activityto be strong with significant portfolio reallocations and rebalances occurringto take advantage of the opportunities that exist.

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

We believe we can capitalize onthis opportunity for 2008. The consistency of Lehman's senior management team, andthe strength of our brand and reputation, are reassuring to our clients, andhave already let in recent significant mandates for the firm. Conservatively,our view right now is that the asset prices in the fixed income market willbegin to stabilize over the next six months, which will serve as an inflectionpoint 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 effectsof 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 thatwe have been able to mitigate the severe impact of a significantly lowermortgage business run-rate all year.

Let me conclude by noting, thatthis was an extremely challenging period in the global markets. Although wewere clearly impacted, we were able to navigate these markets relativelysuccessfully and post a reasonable financial performance. We would attributethis success to our better business mix and geographic mix today, as well asour strong risk and liquidity management. We believe the current markets willpresent us with a significant number of client and trading opportunities, as a resultof the market dislocations. We currently have ample liquidity and capital inplace to enable us to successfully meet these challenges, capture theseopportunities 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, ourDirector of Investor Relations. This is Shaun's 56th earning call for LehmanBrothers and she is retiring in the early part of next year. So on behalf ofthe firm and I am sure many people on this phone call, I just want to saythanks for all of her great work.

Now, Chris and I will be happy totake questions.

Question-and-Answer Session

Operator

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

Guy Moszkowski - Merrill Lynch

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

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

Chris O'Meara

Okay. Well, Guy, as we saw inthis quarter, the credit spread widening extended out, it really affected moreproducts this time and went up the capital structure. So, we saw the big creditspread 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 anythingelse.

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

Guy Moszkowski - Merrill Lynch

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

Chris O'Meara

Certainly, we would expect apullback in the amount of securitize product volume that's going to runthrough, particularly on the origination side. So, new issue, we would expectto come down pretty significantly, for some period of time. The good newsthough is, that this shifts from being an origination opportunity to asecondary trading opportunity. So, our thought is that, when the market reachesequilibrium the activities will pickup, and there will be lots of secondarytrading opportunities for us to help transition our clients who want to move inand out of these products, and also for us as a risk taker on this. So, whenyou think about what the margin decrease would be, certainly, it would besignificant on the primary side, but we think at least part of that we'll madeup on the secondary side. And as we look out, we talk about this $830 millionof write-down that we experienced in this period from the significant creditspread widening, certainly, we wouldn't expect that to recur and we're sort oftrying to give information around where we think the revenue generation rate isof that fixed income business as we look forward, if you exclude that $830million 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 aswe talked about in the past, the formation of capital to take advantage of thestressed opportunities in the securitized product space is taking longer thanin the leverage loan space which is exactly what we anticipated, given the needto migrate the intellectual capital around that business away from the streetto the buy side. But we are starting to see that happen, funds are popping uphere and there and as we get more capital formation there, new secondarytrading opportunities will really come through for us and we are wellpositioned with the in-house expertise and with the reputation in the assetclass to do well there. So, I don't think we're looking at that as somethingthat's going to bring us into some margin compression in Fixed Income.

Guy Moszkowski - Merrill Lynch

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

Erin Callan

Yeah, I think that is a faircomment. We sort of need more information fundamentally on the underlying, tohave the confidence for people to really step in there, and I think that's alot easier to do in the leverage loan asset class and it is around in theseproducts. But those relationships, certainly, between, say the ABX and the fundamentalsof those underlying assets, need to stabilize a bit.

Guy Moszkowski - Merrill Lynch

Thanks. And then, I have a finalquestion on VaR Calculation. I think in general, VaR is defined as applying toliquid assets. As assets migrate to level 3, which we have seen a lot of in thelast couple of quarters and you alluded to again today, is there some potentialthat some of those assets fall out of the historical VaR calculation becausethey are no longer liquid? In other words, is there potential for VaR to beunderstated 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 ifthe trading markets have become opaque.

Guy Moszkowski - Merrill Lynch

Okay, that's great. Thank youvery much.

Chris O'Meara

Yes.

Operator

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

Mike Mayo - Deutsche Bank

It's Mike Mayo with DeutscheBank. 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 andwhat was the rest for?

Chris O'Meara

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

The biggest other category andthis is really limited to the securitized products business and the real estatebusiness 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 mortgagebusiness also saw credit spread widening both in the USand in Europe.

So, it's in those categories andthen, of course, CDOs experienced a significant decline as well, we're notdigging it, but to the extent that we are in it there was significantadjustment, that was taken as well.

Mike Mayo - Deutsche Bank

I guess where I'm going with thisis, 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 writtendown your exposures in leveraged loans for that $10 billion, how much of thathas been written down. In terms of the subprime the $5.3 billion, how much ofthat has been written down. In terms of the CDOs, the $1 billion, how much ofthat has been written down?

Chris O'Meara

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

Mike Mayo - Deutsche Bank

So on average, have those beenwritten-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 individualitems, every situation is different. Each one has multiple parts of the capitalstructure that are in the capital raise, and so each one is different. So I'drather not give specifics on what it is. But the math can be done by looking atthe high yield market industries of both the LCDX and other high yield indices.

Mike Mayo - Deutsche Bank

And then the $5.3 billionsubprime?

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 thesame as the $6.3 million that was here at the beginning of the period. Much ofit is the same because there has been a slowdown in activity, but we have hadsales of whole loans. We have done the couple of securitizations and sold outsenior pieces, not junior pieces. And then we've written-down some things,we've taken on some positions.

But we've had significantwrite-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 lessmeaningful than it was at that terminology with non-investment grade, lessmeaningful than it was at times in the past. The non-investment grade piece andresiduals 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. Weare not suggesting this is a one-off and we're not going to see any furthervaluation 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 forthe better part of the first two quarters of next year. So, we are trying notto be too optimistic. Let's say that this is the bottom and we're now calling thebottom.

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

So we're not calling the bottomhere, we're not suggesting that there aren't going to be further reductions. Ithink what we're suggesting is, we continue to hopefully do a good job indiversifying our risk, staying with the highest quality parts of these assetclasses and also to focus fully on how we can enhance our risk mitigation todeal with that type of an environment.

Mike Mayo - Deutsche Bank

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

Chris O'Meara

Well it's about, when you sayCMBS 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 andrelated category. So, call it about $40 billion, spread out all over the worldthat was written down. We did have some realized gains in Asia,not in the other categories, but that has been written down in a significantway, that's included in the 3.5.

Mike Mayo - Deutsche Bank

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

Chris O'Meara

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

Mike Mayo - Deutsche Bank

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

Chris O'Meara

Mike, we are not giving that, butit’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 MeredithWhitney. You may ask you question and please state you company name.

Meredith Whitney - CIBC

Meredith Whitney, CIBC. I havegot a few unrelated questions. On the GLG gain, can you walk us through how youget from the $480 million down to a net number? And then, in terms of similartype 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 interms of D.E. Shaw, not officially in the pipeline, but looks likely to be inthe 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 revenuesflow through the Investment Banking segment. On the GLG, can you repeat the GLGquestion?

Meredith Whitney - CIBC

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

Erin Callan

Yes, but could you -- we have therevenues, 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 partof the overall revenue generation in the Firm. We don’t really think about itas being a net item. It's one of the items that are in the Equities CapitalMarkets segment. It’s a lumpy item. We do have other private equity investmentsthat will be generating revenue. We’ve seen pretty consistent, when I sayconsistent meaning, if you look at our four-quarter rolling average, forexample, you would see something like $75 million to $100 million of revenuesthat's coming through from our private equity investments generally. So, thisaggregate of $500 million does represent a lumpy item that's in there that isbecause of the GLG transaction that was executed.

Erin Callan

And one point of clarityMeredith, it's Erin, is just to be clear aboutour stakes in hedge fund managers, on the whole that portfolio, which is now anice diversified portfolio of managers, is really intended to be an earningstool. We do not enter into those transactions with the goal of an exit at thebackend. Certainly GLG turned out very nicely in that sense, but these producegreat returns on our equity investment when we are dealing with really strongmanagers that we have invested in. And so, we are not looking at a pipeline ofthose managers to suggest realization events over time. We are investing inthose managers, because they have a lot of synergies with our business. Theyproduce great returns on equity for the Firm. And that's how we are thinkingabout those going forward.

Meredith Whitney - CIBC

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

Erin Callan

Obviously, that would beinformation, especially in my current role and in my prior role that wecouldn't possibly divulge in consistent with Securities Laws violations.

Meredith Whitney - CIBC

I wasn't asking for a name, justgenerally, right?

Erin Callan

We only have about six to sevennames 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 tocome to market. So, is that a possibility for any good, strong welldiversified, long-standing hedge fund managers? Yes. Are there many, many whoare not going down that path for lots of cultural reasons? Yes. So, I reallycan't comment on that.

Meredith Whitney - CIBC

All right. Thank you.

Operator

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

Glenn Schorr - UBS

UBS. Thanks. How about just asimple one? How come the balance sheet or your net assets keep going up? I knowthere 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 leastbring in leverage a little bit?

Chris O'Meara

Well, we are certainly mindful ofwhat's happening there, Glenn. As we build our equity base, we are rolling ourfirm. So as we build our equity base even through periods of stress, you lookat how much equity we've actually generated and held in the organization, ascapital 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 interms of headcount resources and also in financial resources to run thebusinesses. 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 totake ground from our competitors, with our clients. So, the fact that wecontinue to make our balance sheet accessible for client business is crucial tohow we are thinking about moving forward into 2008.

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

Glenn Schorr - UBS

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

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

Chris O'Meara

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

A lot of these hedges are life oftrade hedges. But your point, if you do get into a place where the marketstabilizes and there is a movement in these assets, you are going to dynamicallytry to reposition your hedges and work with the counterparties to move out. AndI 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 getoversold just because there is more hedging. People who want hedges, use theABX. But on these other ones, there is, as I mentioned, lots of differentindexes that you can point to the set hedges, but they are bilateral hedges andyou are going to work with those counterparties to move out of them.

Glenn Schorr - UBS

Okay. The point of clarificationon your level 3 comments at 13%, if I remember correctly, that's up from around12% if your fair value positions went up in line with your net assets. Thatmeans level 3 assets went up a couple of billion from last quarter. Is thatabout right?

Chris O'Meara

I think it was about 11, Glenn, so11 to 13 is yes. It’s a few billion, maybe $6 billion.

Glenn Schorr - UBS

Yes. And then, is that stuffmoving in from level 2, similar to last quarter, less liquidity or is theresome --?

Erin Callan

Some of that.

Chris O'Meara

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

Glenn Schorr - UBS

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

Chris O'Meara

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

As you move down the capitalstructure, there are transactions being executed. Maybe there are some, butit's not as visible and there’s not as much information on it. And so, the wayto 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 capitalstructure for ABX.

And so those inputs or thatinformation around the ABX is used to price out the cash products in the bottomparts of the capital structure. But there are some trades being done. We've gotgood visibility into them. There are many of them that are being done, becausewe are around them. We are either participating in them or we are having a lookat them for the most part. And so, we do have intelligence around the pricinginformation for these instruments.

Erin Callan

And I think one just thinkingabout that and below the AAA part of the cap structure -- I mean obviously theABX is transparent in terms of its inputs and HPA assumptions. So take a lookat that and give you some good guidance as to what the cumulative lossassumptions are.

Chris O'Meara

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

Glenn Schorr - UBS

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

Chris O'Meara

Well, I think last time, wetalked about the leverage loans being down well over $1 billion. But I don'tthink we talked about our mortgage assets last time, but that was also wellover $1 billion in the third quarter. So, think about that as a couple of billionmore 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 thesubprime 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 rangegrowth 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 yourquestions and please state your company name.

William Tanona - GoldmanSachs

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

Erin Callan

Hi.

William Tanona - Goldman Sachs

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

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

Chris O'Meara

Okay. Two pieces on it, when wesaid -- my comments were either hedged or have credit reserves to make theexposure minimal. So, we do have exposure to monolines. There are a number ofdifferent players in the industry where we have bought protection and in somecases that protection will be reliable and in some cases it won't be. We'veevaluated that and we have set up hedges on the credit worthiness of thoseenterprises in the CDS market. So, these, their credit defaults swap straightin the CDS market or many of them do and have and we have bought CDS protectionon 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'veset up reserves appropriately.

Erin Callan

Yes, I think, William, if thereis a reasonable amount that is actually we would look at sort of money in ourfavor actually, in terms of the monoline exposures that we have and as Chrispointed out, we've been aggressive about taking reserves on that and basicallyassuming that, there will be a little performance there. So, it's a prettypositive 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 theirspreads that if you are using those type of products to hedge yourself that youwould booking these type of gains today. And if they were to ever run intoissues you had be downgraded or that exposure would have come back to you, thatyou would have to pick those losses at a later date? But it sounds like whatyou'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 exposurefor us as a Firm, which is, obviously not going to be quite the case across theboard in the industry, but we are talking about a pretty small number trade.

William Tanona - Goldman Sachs

Okay, that's great. And then thesecond question, in terms of, listening to your outlook and listening to otherpeople in the marketplace. Obviously, I think there is a little bit more of acautionary tone around the capital markets here. Just wanted to get a sense asto how you are thinking about the non-comp expenses? Obviously, I know you guysare still growing and that you are looking to grow the business and stuff, butwhen 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 controllingthe non-comp expenses as we enter into what may be a little bit of softer patchhere?

Erin Callan

Yeah, I think, William, if youlook at the 996, Q4 NTE number has really a good run rate to annualize for 2008something 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 tooccupancy as you would expect and a lot related to opening offices in newregions 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 '08projection, but as we try to be countercyclical investors here, we are nottalking about a big jump, but we are talking about roughly 5% or so.

Chris O'Meara

Yeah, apart from the run rate inthe fourth quarter.

Erin Callan

The run rate in the fourthquarter, yeah.

William Tanona - Goldman Sachs

Okay, great. That was helpful.

Operator

Our last question comes fromDouglas 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. Firstoff, I believe you've provided your prime brokerage accounts at year-end, Ithink you said 630, I was hoping maybe to get that this time last year November2006?

Chris O'Meara

About 525.

Douglas Sipkin - Wachovia Securities

525. Thank you. And I believethere were some incremental mortgage charges this quarter for some of thereductions in your origination capacity. I think you'd put that out. Can yougive us that number as well?

Chris O'Meara

Yeah, the non-comp piece of thatwas just north of 15, it was 18 and then the comp piece was absorbed in our49.3% comp ratio versus revenues. So, as we look forward, those personaladjustments have been taken.

Erin Callan

Yeah, 18 compares to 44 for Q3.

Douglas Sipkin - Wachovia Securities

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

Erin Callan

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

It's very hard to judge and Iguess, 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 thatmaybe people are doing it like us, maybe not. It's hard for us to tell.

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

Chris O'Meara

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

Douglas Sipkin - Wachovia Securities

Okay, great. Thanks for taking myquestions.

Chris O'Meara

Okay, see you.

Erin Callan

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

Chris O'Meara

Okay. Thanks everybody.

Operator

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

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