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Executives

Philip Pendergraft - CEO

Kevin McAleer - CFO

Analysts

Rich Repetto - Sandler O'Neill

Mike Vinciquerra - BMO Capital Markets

Howard Chen - Credit Suisse

Susan Colton - JPMorgan

Patrick O'Shaughnessy - Raymond James

John Langston - Hodges Capital

Penson Worldwide Inc. (OTC:PNSN) Q1 2008 Earnings Call April 24, 2008 10:00 AM ET

Operator

Good morning, and welcome to Penson Worldwide's conference call. Our speakers today will be Philip Pendergraft, Chief Executive Officer and Kevin McAleer, Chief Financial Officer.

Before we begin, I'd like to read Penson's Safe Harbor statement. Please note that this presentation contains certain forward-looking statements about management's goals, plans and expectations which are subject to various risks and uncertainties outlined in the Risk Factors section of Penson's Securities and Exchange Commission filings.

Actual results could differ materially from those currently anticipated and we disclaim any obligation to update information discussed in this call as a result of developments which occur afterwards.

At this time, all participants have been placed on listen-only mode and the floor will be opened for questions and comments following the presentation.

I would now like to turn the floor over to Mr. Pendergraft, Chief Executive Officer. Mr. Pendergraft, you may begin.

Philip Pendergraft

Good morning and let me clear up any questions that you might have right away. I have not been promoted to Chief Financial Officer. I continue to keep my preexisting title of Chief Executive Officer and Kevin is still the only CFO we have. So having gotten that out of the way, thanks for joining us this morning.

I am here today with Kevin McAleer, our Chief Financial Officer.

On this call, I will review our overall performance for the quarter. Kevin will make a few comments and then we will end our presentation with an update on interest rate sensitivity and on our general outlook for the rest of the year. And then of course, we will be pleased to take your questions.

Last night, we released our results for the first quarter. On a year-over-year basis, net revenues of $70 million were up 24%. Non interest revenues were up 39%. Net income of $8.1 million was up 13%. Earnings per share of $0.32 was up 19% year-over-year, a stronger increase than that of net income due primarily to the benefit of a lower share count than in the same quarter last year.

Now we achieved these numbers despite the impact of sharply lower interest rates in the most recent quarter when compared with the prior year quarter. We estimate that the 200 plus basis point difference in the average targeted federal funds rate reduced pre-tax income in the first quarter by approximately $3.5 million or $0.09 per share in net income.

The key drivers to our business during the quarter included strong market volumes, revenues from new correspondents and new products, and the benefit of the three acquisitions we've made over the last year.

On a sequential quarter basis, non-interest revenues were down 2% in the first quarter, which did include two fewer trading days than in the fourth quarter of last year. On a revenue per day basis, non-interest revenues were up 1% to a record high.

Net interest revenue on customer balances as was expected on a sequential quarter basis declined by about 24%. Roughly 90% of this decrease came from the 32 basis point lower spread in our customer asset business.

Now while first quarter market volumes were very good, as you all know, it's been a little bit weaker thus far in the second quarter, and if the trend continues, it could affect results in the second quarter.

In addition, the Fed is meeting next week and it remains to be seen what they will do with regards to interest rates and that could also have an impact on our second quarter results.

Another area of good progress during the quarter was on the new business front. We added a net of three securities and four futures correspondents during the quarter, giving us a quarter-end total of 246 correspondents on the securities side of our business and 38 on the futures side. In total, that's an 11% increase over the same quarter last year.

Not included in these numbers are another 14 correspondent firms that have signed contracts with us, but have not yet begun clearing with us. And even beyond these firms, we have a strong pipeline of prospects.

I'd like to note that due to timing, the timing it takes to convert new correspondents, few of the first quarter signings contributed to first quarter results and the correspondents that we signed in the second quarter most likely won't begin significantly contributing to results before the second half of the year.

Nonetheless, this year has been very promising for us both in number and in size of new correspondents.

Let me tell you about some of them.

First, we have been selected by a major online broker to clear the advanced option trading platform that they will be launching later this year. They were attracted to us because of our strong capabilities in the processing of retail options.

Second, is a major domestic quantitative trading firm, which we anticipate will begin clearing through our U.S. clearing broker this quarter. They were attracted to us because of our high volume processing capabilities and we anticipate that they will quickly reach our top ten customer list globally.

Third, we have reached an agreement with MONEX Securities, one of the leading retail securities firms in Japan, with more than 750,000 client accounts. We anticipate launching an online U.S. securities offering for MONEX clients in Japan before the end of this quarter. And MONEX was attracted to us because of our growing track record in helping technology enhance brokers in the Far East trade U.S. securities.

Formal press releases related to these clients will be made at a later time, as appropriate, but we wanted to give you a flavor of the kind of progress we are making. We are very pleased to be associated with all of our new correspondents, but felt that these were especially noteworthy.

Turning to our operating units, during the first quarter, the U.S. securities clearing operation experienced a 10% revenue decline on a sequential quarter basis, as this business has the largest net interest revenue of any of our operations and was the business most affected by the interest rate decreases.

Net interest revenue was down 27% and non interest revenues declined 4%. However, PFSI did begin processing for seven new correspondents during the quarter and has another nine signed in the pipeline.

Our Canadian securities clearing operation had another solid quarter, as revenues from some of our newer correspondents, including Lehman, Cantor Fitzgerald, and thinkorswim, began to contribute to earnings. We found that our consulting practice there, known as Market Essentials Group, has been an important contributor to many of our new client wins in Canada over the past year, as we now have five additional firms signed and awaiting regulatory approval. We believe that of the six new entrants into the Canadian market in 2007, we signed five of them.

Turning to Penson GHCO, our futures business had a very strong first quarter. The initial stage of our First Capitol integration was completed on time and as planned and has already become accretive to results.

Futures revenue was up 175% over the year ago quarter and up 41% on a sequential basis and our customer segregated funds hit an all-time high of $345 million during the quarter.

Now our UK securities business did well, with the exception of weakness in their contract for difference, or CFD business, where volumes declined due to technology and regulatory issues at a correspondent.

As for Nexa, our technology subsidiary, the CFD weakness, plus some delayed development projects caused this operation to experience a small loss in the quarter. Some of these development projects are back on schedule and we continue to believe that Nexa will be profitable for the year.

With the addition of MONEX, you can continue to see how our Penson Asia effort has begun to bear fruit. We now have five correspondent relationships, including ICICI Bank, the largest online broker in India. We anticipate additional referrals for our regulated subsidiaries from our technology efforts in Asia.

Turning to revenue and expenses, looking at our non-interest revenue lines first, clearing and commissions increased 6% sequentially and 48% year-over-year. Here we benefited from strong volumes in all markets for most of the quarter and from our growing base of correspondents.

Technology revenue was up 6% sequentially and 59% year-over-year. Recurring revenue was up 54% compared to the year ago quarter, as our technology clients continued to broaden their base of users, creating more transaction and account fees.

Our other revenues were up 8% over last year but down 26% on a sequential quarter basis from the record level achieved in the fourth quarter. This sequential decline was due to lower revenues from our foreign exchange and trading businesses and lower execution fees associated with options and CFDs. We are currently seeing an improvement in most of these areas, although we do not expect to see a return to the fourth quarter levels this quarter.

Turning to net interest revenue, that breaks down into two parts: customer-related interest and conduit interest. In the customer-related business, our net interest spread declined 32 basis points from the 2007 fourth quarter. 7 basis points of the decline were due to balance mix, primarily due to the growth in customer deposits, which have a relatively smaller spread. 25 basis points of the decline were due to the reduction in the federal funds rate in the first quarter and the latter part of the fourth quarter. The impact of these reductions in the fed funds rate was partially offset by a 2.5% sequential growth in average interest earning balances.

We are continuing to see growth in customer balances, although at a somewhat lower overall spread than our existing book of business. This is because we are seeing most of this growth from our largest correspondents.

Now, our portfolio margin business continues to grow. We now have 212 portfolio margin accounts open, with margin debits totaling a $144 million at the end of March.

Meanwhile, our conduit business has been very strong. Net interest revenue was up 34% on a sequential quarter basis to $2.6 million, and the spread increased to 77 basis points from 54 basis points in the fourth quarter.

Here, we are benefiting from our growing securities lending box, and from the strong team that is running this business. We anticipate continuing growth in balances and better than normal spreads in this business in the second quarter.

Looking at expenses, we continued to benefit from lower clearing and execution charges and year-end rebates, as industry volumes have resulted in record low per unit charges. This expense category is generally lowest in the fourth and first quarters. We also have lower expenses related to CFD transactions because of the decline in CFD volumes.

As we noted in our news release, our operating margin came in at 18.4% versus 21.2% in the fourth quarter and 20.1% in the year ago quarter, that largely reflected the decline in net interest revenue, increased interest expense associated with acquisitions and share repurchases.

Now I would like to ask Kevin to make a few comments.

Kevin McAleer

Thank you, Phil, and good morning. I want to review our share count reconciliation, and comment on our balance sheet and our acquisition strategy.

With regard to our share count, weighted average diluted shares outstanding were down approximately 1.4 million year-over-year. This is primarily due to two factors. The first was the share repurchases made in the second half of last year and the repurchases of 405,000 additional shares in the March 2008 quarter.

Partially offsetting this was the issuance of a combined total 194,000 shares we paid for the acquisition of First Capital Group as well as the payment for the CCS acquisitions, their quarterly performance.

As contemplated under our terms of the Schonfeld asset purchase agreement, Schonfeld has agreed to allow Penson, in our sole discretion, to make the first earn-out payment either in cash or stock. As a result, the March 2008 quarter has 669,000 less weighted average shares diluted than the December 2007 quarter.

When we look at our balance sheet, you will see that we have grown approximately $450 million or approximately 7% to $8.3 billion. Now this is primarily the result of the growth in our correspondents, as Phil mentioned, and the growth of segregated assets in the futures business hit a record, as well as the addition of new correspondents.

We have mentioned several times that we are looking for a treasurer to manage this global balance sheet of $8 billion plus.

I am pleased to announce that we have hired Ray Carli as our Senior Vice President and Global Treasurer. Ray has more than 25-year career history in treasury operations for some of the world's largest financial services firms. His experience is a very, very good fit for our business. Most recently, Ray was Senior Vice President and Global Treasurer for Cantor Fitzgerald. Prior to Cantor, he held treasury positions with increasing responsibility at Nomura, CS First Boston in Tokyo as well as in New York and we are very pleased to welcome Ray aboard. He will be starting at the beginning of May.

And last, on the acquisition front, while we continue to actively hold and hold discussions and look at opportunities, the valuations that we are seeing do not appear to be in line with the current economic or market conditions. We don't currently anticipate any activity on the immediate horizon, but we continue to look.

And now, here is Phil to wrap up the presentation.

Philip Pendergraft

Thanks, Kevin. As we look ahead to the rest of the year, we would like to update on interest rate sensitivity now. In the first quarter, 73% of net revenues were non-interest related, 4% were related to our conduit business and 23% was related to our customer asset business.

Our customer asset business is the one area that is directly affected by the declining interest rate environment.

Based upon our first quarter average balances and the current 2.25% targeted federal funds rate, we anticipate that each additional 25 basis point decline in the fed funds rate will reduce pre-tax income by $6 million over the following 12 months. This is the same amount that we estimated last quarter and has not increased primarily because of the current makeup of our balances, as well as our continued structuring of correspondent contracts to better insulate ourselves from rate changes.

As we look ahead for the rest of the year, we are pleased with our overall positioning, which is in line with our growth strategies. We are continuing to grow the balance sheet and sign important new correspondents.

Based on recent trends as I have noted, trading activity appears to have moderated slightly and whether that continues in that direction remains to be seen. Nonetheless, as you can see from our activities, we remain optimistic about longer-term volume growth, which should correlate to higher non-interest revenues.

So in summary, last quarter we said that because of the interest rate headwinds that we faced this year, our biggest objective is to continue to grow the business. We believe that we are doing just that. We had a good quarter in new correspondent acquisitions. We have a great pipeline of both signed contracts and strong prospects. We grew the balance sheet despite market volatility. We are continuing to position the company so that when the headwinds end and then become tailwinds, we will be ready.

Thank you for your interest in Penson and for joining us on this call this morning.

And I am now ready to open up the line to questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Rich Repetto of Sandler O'Neill. Please proceed.

Rich Repetto - Sandler O'Neill

Good morning, Phil and Kevin.

Philip Pendergraft

Rich, good morning.

Kevin McAleer

Good morning, Rich.

Rich Repetto - Sandler O'Neill

Good morning. The first question would be on this other revenue line. You said it wouldn't return to 4Q run rates in the second quarter. Can we go down and get a little bit more detail, because it is very impactful to earnings. Should we get to that run rate in the second half, do you believe, of the year?

Philip Pendergraft

Well, Rich, very specifically, there is a piece of that that I don't anticipate we will get back and that we will have to grow through is that as penny pricing continues to expand in the options marketplace, the execution fees we earn on option executions have come down. And so, that cost us about $1 million in the first quarter.

And so, while we are going to continue to grow our volumes there, that will help to offset the decline, the per unit was down and I don't think that is coming back. So I would say that we certainly anticipate growing past $13 million in other income. But that's the major component that won't recover.

Rich Repetto - Sandler O'Neill

It was down $3.4 million quarter to quarter. So that was one. Could you go through the other sort of differences?

Philip Pendergraft

Sure. I mean, general fees really not associated with trades were down I guess about $1 million and then foreign exchange and trading was down about $1.5 million. And part of that $1 million was related to lower CFD volume.

Rich Repetto - Sandler O'Neill

Got you. Okay. And then, you did an excellent job on the expense on the floor brokerage and exchange and clearing expenses. And you said, there is some seasonal. We also read about how you are aggregating trades. Is there more than just the seasonal decline here, like can we build a lower run rate because of this aggregation of trades going forward?

Philip Pendergraft

Rich, trade aggregation is actually an income item for us. It is not related to clearing and execution expenses. That is more an execution services product that allows our clients to execute under our symbol and for us to benefit from higher ECN rebates and lower ECN expenses. Those all get rolled up together. So I do think that generally speaking, industry costs are down from floor brokerage and industry, clearance costs are down because of record volumes.

And so, I would expect that over the year, we will see this category as a percentage of revenue is going to stay down. But it will be back up some in the second quarter, because we benefited from year-end rebates in the first quarter.

Rich Repetto - Sandler O'Neill

Okay. And my last question would be, on the Schonfeld first earn-out, and I thought Kevin said something about 669,000 less shares. I thought I understood this and now I just don't have it 100% down. Could you explain it one more time? I know you paid in cash and you have accrued shares. What is the actual buyback, implied buyback price of the shares and how many shares could come out of the share count, say in 2Q?

Philip Pendergraft

Well, Rich, actually, there won't be any shares come out of the share count related to this in 2Q, because it's our intention to make the payment in cash. The reason that we had shares in the third quarter and the fourth quarter was because at the time we had an obligation to make a payment in stock and so we had an obligation to accrue those potential shares that were going to be issued.

So essentially what we have done now is, we've agreed, they've weighed any obligation we might have to make a payment in stock, and so we are able to take those accrued shares out of the share count.

Rich Repetto - Sandler O'Neill

Okay. Is there any way just to get the average accrued price ballpark that the 669 were accrued at?

Kevin McAleer

Well, the 669 were based on market value at the end of December. That's a December '07 number.

Philip Pendergraft

Yes, Rich, I think your question -- our obligation to issue shares is based upon the price in a particular trading range, which I think just started. So we accrued the shares in the third quarter and the fourth quarter. We accrued the shares based upon the ending prices of those periods. But our actual obligation, the price of our actual obligation would be determined over the next three weeks.

So we would have had some significant additional share count going into the share count in the first and second quarter had we not elected to make the payment in cash.

Rich Repetto - Sandler O'Neill

Got you. Okay. Thanks, guys. That's very helpful.

Operator

And your next question comes from the line of Mike Vinciquerra of BMO Capital Markets. Please proceed.

Mike Vinciquerra - BMO Capital Markets

Good morning.

Philip Pendergraft

Mike, good morning.

Mike Vinciquerra - BMO Capital Markets

I wanted to follow up on Rich's last question for one second. Do you have an estimate of what the cash payment to Schonfeld is going to be? What's the cash outflow that we should expect on the cash flow statement in Q2?

Philip Pendergraft

It's going to be between $15 million and $18 million.

Mike Vinciquerra - BMO Capital Markets

Okay, great. That's helpful. Thank you. Okay. And then also want to go back on the other revenue. You have been talking a bit about the trade aggregation for the last couple of quarters and it sounded like there might be a little momentum there, but we really didn't see -- it was obviously overwhelmed by the declines in your other products there, where is that trade aggregation in terms of contribution today and did it have much of an impact in the quarter?

Philip Pendergraft

Mike, it didn't grow in the quarter like we had anticipated it would. NASDAQ made some changes in their pricing model that had a negative impact on it. It was pretty flat in the quarter. Now, we are rolling it out on Arca. In fact, I think we just launched it on Arca. So we do anticipate that we will see growth in that product in the second quarter.

Mike Vinciquerra - BMO Capital Markets

So you will benefit where there is tiered pricing, essentially? That's where you can provide a--?

Philip Pendergraft

Exactly. Any place there is tiered pricing, we get a benefit.

Mike Vinciquerra - BMO Capital Markets

Got it. Okay. And I was looking at your interest paying versus your interest earning balances, the averages. And interest paying balances, Kevin, went up about 200 million for the quarter. Interest earning only went up 40 million. So you had a negative mix there. Is there a reason why that mix shifted the way it did? Is it a client mix, something like that? I guess I am looking at 3.6 billion in interest paying balances this quarter versus 3.4 billion last quarter, and then on the interest-earning side, it is like 4.16 versus 4.06 last quarter. And so it is basically a negative 140 million according to my calculations.

Philip Pendergraft

Mike, I don't have the answer to that question at my fingertips, but I will get it for you.

Mike Vinciquerra - BMO Capital Markets

Okay, all right.

Philip Pendergraft

I suspect it was simply just changes in underlying customer balances, but I will find out.

Mike Vinciquerra - BMO Capital Markets

Got it, okay. Thank you. And then I just wanted to dig into the 14 accounts you have signed this quarter, obviously very positive. Any details on a, the type of accounts signed and also I assume this is related to some of the potential fall out from Bear Stearns, or am I looking at it the wrong way?

Philip Pendergraft

Mike, I really don't want to comment on where we are benefiting from. But it has been an extraordinary good year in terms of new client signing and acquisition, including clients that will move the needle.

Mike Vinciquerra - BMO Capital Markets

Is it your typical equity clients? Is it a mix? Is it all U.S.?

Philip Pendergraft

Probably the biggest impacts are going to come in the U.S. and Canada. And they are spread across equity and options customers. We continue to gain market share in the options space and we have had some good success in high frequency trading customers in the first four months of the year. And of course, one of the nice things about those kind of customers, in addition to the fact that they tend to be high volume, is that they are easy to convert. And so we anticipate that the two most significant customers we signed in that space, one has actually started, even though we signed them in the first quarter, and the second we anticipate will begin in April.

And I really think this is fundamentally the result of two major things. When I say this, I mean our successes in adding new customers. One is, we have had an outstanding sales effort led by our sales and marketing heads in New York and that's helped us not only in the U.S., but in Canada.

But then also in Canada, as I indicated earlier, we are winning almost every new entry into that market. And I think that bodes very well for us as we look longer term at market share and market positioning.

Mike Vinciquerra - BMO Capital Markets

Okay. That's helpful. And just to clarify, you have got 14 that you signed in the second quarter and you said nine additional in the pipeline that haven't been signed but you hope to sign?

Philip Pendergraft

No, let me be clear.

Mike Vinciquerra - BMO Capital Markets

Okay.

Philip Pendergraft

The 14 includes nine in the U.S. and five in Canada.

Mike Vinciquerra - BMO Capital Markets

Okay.

Philip Pendergraft

So they are signed, but they have not yet started. In order to be conservative, when we give actual correspondent numbers, those are firms that are actually on our books processing revenue. But because we had such a strong quarter this quarter in prospective signings of firms that have not yet begun, we wanted to point that out.

Mike Vinciquerra - BMO Capital Markets

Got it. Okay. Well, very good, it's positive. Thanks, guys.

Philip Pendergraft

Yes, sir. Thank you.

Operator

Your next question comes from the line of Howard Chen of Credit Suisse. Please proceed.

Howard Chen - Credit Suisse

Good morning, Phil. Good morning, Kevin.

Kevin McAleer

Good morning, Howard.

Philip Pendergraft

Good morning, Howard.

Howard Chen - Credit Suisse

Thanks for all the color on the call. I was curious, is there any seasonal that is compensation related that makes it a touch higher to begin the year? I know historically, it seems your first quarter comp accruals a bit higher than the remaining three, but just wanted to review that again with you?

Philip Pendergraft

Yes, we do pay year-end bonuses in the first quarter that has an impact generally on things like, not on the actual compensation expense, but on associated things like payroll taxes. In some of our entities, particularly in Canada, benefits charges are significantly higher in the first half of the year because of the way the tax issues work up there.

And then also, this year, we have an acquisition. The First Capitol acquisition is in our first quarter numbers for the full quarter, where we only had one month in the fourth quarter.

Howard Chen - Credit Suisse

Okay. Thanks for walking through that. Very helpful. And then second, can you discuss if you think that you are able to have a similar flexibility with the consideration of future earn outs akin to what you were able to accomplish in the first quarter on that first Schonfeld earn-out?

Philip Pendergraft

The way the Schonfeld deal is structured, the first two payments had an obligation -- depending on the share price, we had an obligation to issue shares. So the last two payments, we have the option to issue shares or cash totally at our option. So the first two were the ones where we would potentially be locked into issuing stock and we've now agreed with Schonfeld that we have the right not to do that in this year. So we really only have one year of obligation left.

Howard Chen - Credit Suisse

Okay.

Philip Pendergraft

And that is dependent on share price. If the stock is below $15.30, we have the choice to issue stock or cash. If it is above $15.30, then next year, we will have an obligation to issue shares.

Howard Chen - Credit Suisse

Great, okay. And then, can you just review the timing of all your upcoming earn-outs for the balance of '08?

Philip Pendergraft

We have a payment to Schonfeld at the end of June.

Kevin McAleer

It will be July.

Philip Pendergraft

We have a small quarterly payment to CCS and then at the end of '08, we will have a payment due on our First Capital acquisition, which the magnitude of the CCS and the First Capital are just a few million dollars in total.

Howard Chen - Credit Suisse

Thanks, okay. And then, finally, Phil, in your prepared remarks at the end, you mentioned the potential ability to restructure some existing correspondent relationships, to paraphrase. Could you go into a little bit more detail on how the mechanics of that renegotiation process could work? Do we see a shift of the relationship from fees to net interest income? I am just a little unclear on how that process works.

Philip Pendergraft

Sure. What I was actually referring to, Howard, was that over the last couple of years, we have been moving some of the risk associated with interest rate changes to our correspondent rather than what we've traditionally done is we've borne that risk. And so, as we have continued to renegotiate and as we negotiate new contracts and as we renegotiate old contracts, we are slowly begin to insulate ourselves better from spread risk by essentially locking in a guaranteed spread or a minimum guaranteed spread on our side and sharing or shifting all of that risk to the correspondent. That's what I meant by my comment in my prepared remarks.

Howard Chen - Credit Suisse

Okay. And then, just to follow up on that quickly. Can you quantify like where you think you are in that process, what inning amongst your existing customer base?

Philip Pendergraft

Howard, I really don't have a metric on that. I mean, certainly the customers we've signed in the last couple of years or the contracts we have renegotiated in the last couple of years, we've worked pretty hard to build that into the contracts. We don't always get there. Sometimes we trade that for something else. But that is the direction we are going in order to reduce our exposure to spread risk.

Howard Chen - Credit Suisse

Interesting. Thanks for all the detail on that and thanks for taking the questions.

Philip Pendergraft

Yes, sir.

Operator

And your next question comes from the line of Ken Worthington of JPMorgan. Please proceed.

Susan Colton - JPMorgan

Hi, this is Susan Colton filling in for Ken.

Philip Pendergraft

Susie, good morning.

Susan Colton - JPMorgan

Good morning. So my first question is about the net interest income. If the fed funds rate continues to be at the same level and if asset balances don't change this quarter, where do we think net interest income will go? So, given how much the Fed has lowered interest rates in the first quarter, will there be any kind of hangover effect going forward?

Philip Pendergraft

There will be a little bit. I think we would forecast a modest decline in interest income this quarter.

Susan Colton - JPMorgan

Okay. Do you have any kind of estimate of how much that would be?

Philip Pendergraft

We don't provide that kind of guidance.

Susan Colton - JPMorgan

Okay. And then secondly, can you give us any kind of update on how much margining capacity you have at this point and to what extent portfolio margin accounts are absorbing this capacity?

Philip Pendergraft

Margin capacity?

Susan Colton - JPMorgan

Right.

Philip Pendergraft

Okay, so, we could extend from a capital perspective, we have capacity to make more than an additional $1 billion in margin loans. It depends on the makeup of them, but somewhere between probably $1 billion and $1.5 billion. So we could double our book of business on the margin lending side from that metric. In terms of just having excess customer cash, we have about $1.5 billion in excess customer cash, so we have plenty of funding capability to support that kind of loan as well.

Portfolio on margin is growing. I think we are up to about $144 million in debits at the end of the first quarter and about 200 plus accounts. So it's starting to make an impact in growing or in using excess cash. But we have plenty of excess capacity.

Susan Colton - JPMorgan

Okay, thanks very much.

Philip Pendergraft

Yes, ma'am.

Operator

Your next question comes from the line of Patrick O'Shaughnessy of Raymond James.

Patrick O'Shaughnessy - Raymond James

Hey, good morning, guys. Patrick O'Shaughnessy, how are you?

Philip Pendergraft

Patrick, we are good, how are you?

Kevin McAleer

Good morning, Patrick.

Patrick O'Shaughnessy - Raymond James

Pretty good. Questions for you guys about your share buyback. You have a little bit left under your current authorization and I was wondering if you could update me regarding your buyback philosophy?

And specifically, a question I had was, your cash on your balance sheet is down a little bit. You have the cash payment to Schonfeld coming up in the second quarter. And does that impact how you might approach future repurchases?

Philip Pendergraft

Well, we have plenty of excess capital so I anticipate that we are going to continue the same strategy that we have had underway, which is a patient repurchase program, where we reinvest a portion of our earnings every month and quarter in stock buyback. So I don't necessarily believe it's going to -- we don't have any plans to slow down, but we are not going to accelerate. We are just going to continue to patiently, as the opportunity presents itself, buy stock.

Patrick O'Shaughnessy - Raymond James

Okay, makes sense. Next question, the conduit spread that you guys gave, obviously a pretty huge jump this quarter. I was wondering, you talked about how you think it will probably stay a little bit elevated going forward. And previously, you'd mentioned that the range that we should think about for that spread was about 45 to 50 basis points. So, can you give us a little bit more information about why there was such a big jump this past quarter and why you might expect that to be sustained going forward?

Philip Pendergraft

Well, it is a function of really two things. It's a function of the value of our box, which has grown as our customer base has grown. And so we have valuable merchandise that we are putting out on the street. And so that has certainly increased our spread.

And we have a management team in our stock lending group is very strong and we are benefiting from some of the relationships they have developed over the last -- I guess we have been in this business now two years.

It's not yet a mature business and continues to grow and I think we are benefiting from the management growth and relationship growth that we've cultivated over the last couple of years. I think it's probably unlikely we are going to stay at 77 basis points for forever, but it continues very strong.

Patrick O'Shaughnessy - Raymond James

Okay. And the last question that I had was, last quarter, we talked about how for a 25 basis point cut in the fed funds rate, it would decrease your consumer lending spread by about 13 basis points, if I am remembering that correctly. If I did the calculations correctly, is that bumping up a little bit to about 15 basis points going forward?

Philip Pendergraft

Patrick, I don't have that number in front of me. George says, yes, that is about right.

Patrick O'Shaughnessy - Raymond James

Okay, great. Thanks, guys.

Philip Pendergraft

You are welcome.

Operator

(Operator Instructions). And your next question comes from the line of John Langston of Hodges Capital. Please proceed.

John Langston - Hodges Capital

Hi, guys, thanks for the color again on the net interest spread. One thing I am curious about is, it appears that the reduction in the fed funds rate isn't really affecting your conduit lending business. And I wanted to see if you could give us a little bit more color first to better understand why that is?

Philip Pendergraft

Hey, John. On a net interest basis, that business is not impacted by the absolute level of fed funds. It's a spread business and the function of that spread has more to do with the value of what you are lending out and the scarcity of it than really anything else. And so, the absolute level of fed funds doesn't have an impact on it.

John Langston - Hodges Capital

Okay. Also wanted to see if you might be able to give us -- I think you have done it already, but I wanted to see if you could maybe give us a little bit more color on the impact of the Bear Stearns dissolution might have on you all?

Philip Pendergraft

Well, ultimately, what happened to Bear Stearns is not good for the industry. And so we certainly were very sorry to see that happen. I think that the uncertainty in the marketplace can create opportunity, but certainly Bear Stearns was and remains a very significant competitor. And we anticipate that they will -- I have not yet -- I am not sure that I have heard if JPMorgan has decided if they are going to retain the correspondent clearing business. Clearly an important business of this was the prime brokerage business, where I am sure that they will have a very strong product offering.

John Langston - Hodges Capital

Okay, great. Thanks, guys.

Operator

And your next question is a follow-up from the line of Mike Vinciquerra. Please proceed.

Mike Vinciquerra - BMO Capital Markets

Thank you. I want to follow up on a question that was asked a couple minutes ago on the spread. What is the spread as you exited the quarter? I guess it was a 116 basis points for Q1. Can you just give us a sense where you exited? Then we can all obviously apply our own assumptions as far as what the Fed is going to do?

Kevin McAleer

Okay, we are looking that up right now to make sure we have the right...

Mike Vinciquerra - BMO Capital Markets

Okay. Then let me ask another question while you are doing that, if that's okay. In the futures market, you mentioned you have 38 correspondent clients now. Are you only servicing non-clearing FCMs in that business? I presume you are also servicing buy-side and commercial accounts. So are there accounts outside of that 38 that are part of the--?

Philip Pendergraft

Absolutely. The 38 are FCMs and introducing brokers. We do have professional trading groups, commercial accounts, a number of other customers that are not in that number. It is just because that's a metric that we have used more broadly in our business. We have included the IBs and FCMs in our statistics.

Mike Vinciquerra - BMO Capital Markets

I see. Okay.

Kevin McAleer

Their customer count is north of 400 in total.

Mike Vinciquerra - BMO Capital Markets

Got it.

Philip Pendergraft

Mike, the number is 106.

Mike Vinciquerra - BMO Capital Markets

106, very good. That's very helpful. Thank you. And then, I just wanted to ask one more question on the futures side. We heard from one of your competitors in the futures space that they are seeing some small FCMs convert to essentially prop trading shops because of capital constraints and things like that and just shifting their business model. Are you seeing any traction in terms of capturing some of those folks who are small FCMs that decided that is not the type of business they wanted to run?

Philip Pendergraft

Mike, there is a lot of turmoil in the space. We are seeing opportunities like the one you just described as well as opportunities from larger firms that with interest rates down and with all the volatility, are looking for strategic alternatives.

Mike Vinciquerra - BMO Capital Markets

Okay, very good. Thanks, guys.

Philip Pendergraft

Yes, sir.

Operator

And this does conclude the question-and-answer session. I will now turn it back to management for closing remarks.

Philip Pendergraft

Thank you for your interest in Penson and for your time this morning. I want to remind you that we will be holding our annual meeting on Tuesday, so if anybody is in Dallas, please come and visit us. We will be visiting with investors with Raymond James during the month of May and presenting at the Sandler conference in New York in early June and at the UBS conference in London later in June.

We look forward to chatting with you again, when we will be reporting second quarter results in the latter part of July. Thanks again for joining us today, and thanks to all of our customers and staff around the world for their contribution to this quarter's results. You all have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Penson Worldwide Inc. Q1 2008 Earnings Call Transcript

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