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Executives

Don Hultgren - President and CEO

Ken Hanks - CFO

John Holt - President and CEO, Southwest Securities, FSB

John Ross - President and CEO, Southwest Securities and SWS Financial

Jim Bowman - VP, Corporate Communications

Analysts

Edward Hemmelgarn - Shaker Investments

Erin Caddell - Hovde

Tripti Prasad - Sidoti

SWS Group Inc. (SWS) F3Q08 (Qtr End 03/28/08) Earnings Call May 7, 2008 9:00 AM ET

Jim Bowman

Good morning, everyone and welcome to the SWS Group quarterly conference call and webcast. This is Jim Bowman of the SWS Corporate Communication staff. We are pleased you could join us today. The SWS quarterly earnings release can be found on our website at swsgroupinc.com or on the Yahoo Finance website under SWS News.

Market professionals on our distribution list should also have received the slides for today's call via e-mail. If you would like to be added to our e-mail list to receive news releases or to be notified of future quarterly calls, please contact us at 214-859-9335. This conference call is being webcast live on the internet, along with the accompanying slides at swsgroupinc.com, where it will be archived for the next 30 days. (Operator Instructions).

This presentation contains forward-looking statements regarding the Company's future overall performance. You are cautioned that any forward-looking statements, including those predicting or forecasting future events or results which depend on future events for their accuracy, embody projections or assumptions, or express the intent belief, or current expectations of the Company or its management, are not guarantees of future performance and involve risks and uncertainties.

Actual results may differ materially as a result of various factors, some of which are beyond our control, including but not limited to, volume of trading in securities, volatility of securities prices and interest rates, customer margin loan activity, creditworthiness of our correspondents and customers, demand for housing, loss of correspondents to self-Clearing or as a result of consolidations or otherwise, and those factors discussed in our annual report on Form 10-K and in our other reports filed with and available from the Securities and Exchange Commission.

This conference call also contains references to non-GAAP financial information, which is being presented to provide additional information regarding the Company's operations and should not be used in place of GAAP measures. The Company's news release and today's slides include reconciliations of these non-GAAP measures with the Company's GAAP results.

At this point, it is my pleasure to introduce Mr. Don Hultgren, President and Chief Executive Officer of SWS. Don?

Don Hultgren

Thank you, Jim. Good morning, everyone. Thank you for joining us for our third quarter conference call this morning. I would like to start by introducing the participants. Joining me today is Ken Hanks, who is the Chief Financial Officer of SWS Group; John Holt, who is the President and CEO of Southwest Securities, FSB, our bank; also here is Jim Ross, the President and Chief Executive Officer of Southwest Securities and SWS Financial.

Let me begin by reviewing the agenda. I would like to first provide an overview of the third quarter, review some of the noteworthy items in that quarter and touch on some important events since our last conference call. Ken will then provide a more detailed review of the third quarter; and then, John will provide an update on activities at the bank. I will discuss our market position and our three primary growth initiatives at the end. And then finally, we will open it up for questions. In order to ask a question, it is star one on the telephone or questions@swst.com.

Let's start with an overview of the third quarter. Our net revenues in the quarter increased from $64 million last year to $74 million this year. Income from continuing operations also increased from $7.6 million to $8.6 million. Earnings per share in the second quarter increased from $0.28 last year to $0.32 this year.

And finally, we ended the quarter with a book value per share of $11.69. In recent quarters, we have highlighted unusual and onetime items that have affected our quarterly results in order to help you better understand our operations. This time there was only a marginal impact in last years third quarter, relating to our ownership position in NYX, and as you can see, it was not sufficient to impact earnings per share. As this position has been transferred from the brokerage firm to the parent Company, it no longer impacts our earnings each quarter.

Turning now to noteworthy items, a number of our business units turned in very strong results in the third quarter. The taxable and tax free income groups were two of these units. Management of these groups took advantage of recent tough markets to expand their operations. Many firms sought to reduce their presence in fixed income in those tough markets, which created an opportunity for Southwest Securities to hire numerous experienced and talented producers. You could say that we bought straw hats in the winter.

Now that we have those straw hats, in summer, not just here in Dallas, but more importantly in the fixed income market. The yield curve has returned to normal and activity has picked up substantially. The improved market plus the growth of our talent pool resulted in fixed income commission revenues being up 139% compared to last years third quarter. Another opportunity was created for our municipal group, when interest rates and auction rate municipal bonds increased sharply.

Our municipal team took advantage of this by investing on behalf of the firm in this market. The return on equity from these investments is extremely high. The focus of the portfolio is generally on investment-grade municipal bonds from issuers that our team knows very well. In fact, none of the auction bonds we have held in this portfolio have failed, none of the auctions for those bonds have failed. At the end of the quarter, our portfolio of such investments was $137 million.

In yet another example of competitors exiting a market in difficult times, many banks have left the mortgage purchase business this is a business in which we facilitate the closing of mortgages. Mortgages are purchased from originators, than sold to prearranged buyers generally in less than 30 days. As competition has decreased, the management of this division has been able to dramatically grow assets while also improving quality.

Average balances in our mortgage purchase program were $273 million in the third quarter compared to $99 million in the same quarter last year. The stock loan group had a very good quarter, because of the turmoil in the credit markets the spread in the stock loan business was 78 basis points above where it was in last years third quarter.

Finally in a note that's not on this slide, we did repurchase in the quarter 551,056 shares of our stock at an average price of $11.07. Originally, we had authorization to buy 1.25 million shares; we still have about 700,000 shares left available under that authorization.

Let's turn to important events. Since our last conference call there have been a number of these events here at SWS Group. A new Chief Operating Officer was hired in Southwest Securities, FSB. This guy brings a wealth of experience and has hit the ground running. He adds an additional depth to an already strong management team at the bank.

The bank has a high energy management team that is focused on growing through the addition of new bankers. Focus at the bank also led to the divestiture of the factoring business. The business just did not have critical mass. The returns that we were able to achieve did not outweigh the risks. So the bank sold the business and recognized a gain of $666,000 on the sale.

Also at the bank, management was very busy at the bank this quarter we purchased a $30 million SBA portfolio. Last quarter, we hired a team of SBA lenders in Fort Worth. This is a portfolio which they had managed prior to coming on board with us. The bankers know and are comfortable with the credits. This purchase helps us to better diversify our loan portfolio.

Finally, we closed on the acquisition of M.L. Stern. I'm very pleased that 97% of our retention offers to their top producers have been agreed to and finalized. The specifics of what M.L. Stern brings to the table are shown on the next slide. As you can see, it about doubles the size of our private client group with approximately 100 full-time brokers; increases our assets that we control by $4 billion. It adds seven locations, as you can see those locations are in California and Nevada.

And their product specialty is municipal bonds, which is very attractive to us for a number of reasons. First is that we already have a public finance effort in California, so this dovetails well with that. The second is that this has not historically been a strong area in our private client group. We currently do about 2% of our business in municipal bonds, whereas M.L. Stern does 41% of their business in municipal bonds. So we are anxious to learn from them how we can improve that business.

Finally, we also acquired as part of that transaction Tower Asset Management, which has approximately $450 million in managed assets. We're very excited that we have been able to get into the money management business through this acquisition as well. So we are thrilled to welcome the M.L. Stern family to SWS Group.

With that, let me turn it over to Ken.

Ken Hanks

Thanks, Don. Good morning, everyone. Today I would like to spend a few moments discussing our usual quarterly financial and operational data, and then focus on our segment results and general statistics. Additionally, I would like to remind listeners that there are no amounts included in these results related to our new M.L. Stern subsidiary. Those will begin to be included in our financials in the fiscal fourth quarter.

First on the income statement, net revenues, that is operating revenues plus interest revenues, less interest expense were up by $10.6 million or 17% in the third quarter, while pretax earnings were up by $2.7 million or 24%. Total operating revenues that is revenues excluding interest income, were up by 13% or $5.5 million from the previous year for the third quarter.

I will speak about each income statement line items a little later in the presentation. Net interest income that is interest income less interest expense was up by 23% or $5.1 million for the quarter. Finally, operating expenses, which excludes interest expense, were up by $7.9 million for the quarter.

Turning to the individual operating revenue line items. Net revenues from Clearing were up $558,000 or 19% for the quarter. In the quarter, we processed 8.9 million trades, up from 3.9 million in the same quarter a year ago, and 8 million in the second quarter. General Securities tickets were up 44% while daytrading customer volume was up 134% from the year ago period.

Revenue per ticket in the March '08 quarter was $0.40 versus $0.77 per ticket in the same quarter last year. This change is primarily attributed to the additional volume from daytraders in the current quarter over last year.

Commissions were up $5.3 million or 24% in the quarter, as the fixed income business units posted substantial improvement over the same quarter last year. Commission revenue was up $6.2 million in our institutional brokerage segment as volatility produced increased volume, and client activity in the fixed income market increased.

Portfolio trading commissions were down slightly from last year. The Retail segment commission revenue was down 7% from last year's quarter as uncertainty in the market reduced Retail customer volume. Investment banking and advisory fees were down 3% in the quarter, with declines in both the municipal finance and corporate finance businesses. Managed account fees were about even in the quarter while money market fees were up due to increased balance.

Net gains on principal transactions were down $557,000 from last year. The primary driver of the decrease came from fewer taxable fixed income trading profits. Last year, we've recorded a $375,000 loss on NYX stock; while this year, the change in value is recorded in other comprehensive income in the equities section of the balance sheet. Other revenue is up $397,000 for the quarter. The bank sold its factoring division in the quarter, generating a gain of $656,000.

Net interest revenue, which is interest revenue less interest expense, of $27.5 million was up 23% from last year's quarter. The bank's net interest was up 5%, while net interest at the brokerage was up 43%. The increase in brokerage net interest was related to our securities lending area, where we saw spreads increase by 78 basis points over last year. Net interest in this area was up by $5.8 million, while net interest from Retail and Clearing customers was down $1.9 million.

The Fed rate cuts during the quarter had a moderate impact on margin balance spread, but a dramatic impact on the marginal spread earned on credit in the Retail and Clearing businesses. While we have some flexibility in setting our interest rates, generally our brokerage assets reprice more quickly than our liabilities. Average margin balances in the customer side of the brokerage business of $299 million are flat with the previous quarter and the same quarter last year. Credit balances are up slightly from both December and March of last year.

Stock loan balances are flat from December, but up 8.5% from last year. As discussed, this business line benefited primarily from increased spread rather than balance growth. The bank's average loan balance was up 11% over the December quarter and 34% over the prior year. The growth here continues to be in the purchased mortgage program as Don discussed earlier. We're still seeing good growth in other loan categories with the exception of interim construction lending.

Turning to operating expenses. Operating expenses were up $7.9 million from the prior year's quarter. Compensation increases account for $5.7 million of the increase in operating expenses. Variable commission and incentive compensation in the institutional segment comprised over 90% of this increase, while increased headcount at the bank contributed most of the remainder. Occupancy and equipment expenses were up slightly, generally due to increased rent on new locations.

Communication expense was up 12% from additional quote fees for new locations and additional users. Floor brokerage expense was down $1.2 million and actually appears as a credit in the expense section of the income statement, as the annual rebate we received from our Clearing house was about double our normal rebate. Promotional expenses were up slightly. Other expenses were up $2.9 million due to a $739,000 increase in the provision for loan losses at the bank, increased legal fees, and expenses at the bank associated with REO properties.

This next slide presents operating results by segment, our first segment is Clearing. This business encompasses our share of all of the fee revenue collected from our correspondents or their customers, as well as the net interest earned on correspondent and correspondent customer accounts. For the third quarter, this segment earned $3 million, down from $4.8 million last year.

Volume increases led to an increase in Clearing fees, but compressed interest spreads reduced allocated interest income in this segment. In addition, expenses in this segment have increased, as we have hired new management. Allocated information technology and operational expenses have also impact of this segment, as other segments have become more efficient by compressing their trades this segment has picked up much of that underlying fixed cost.

The Retail segment encompasses our private client group as well as our independent contractor brokers that are housed in SWS Financial Services. This segment also includes the product lines that directly support those two sales forces. The volatile market environment negatively impacted the Retail business in the March 2008 quarter, reducing profitability by a third. While our recruiting efforts produced some successes in the quarter, the compressed interest spreads and volatile market led to reduced revenue.

Operating expenses were also up from new offices opened since March of last year as well as increased technology costs. The Institutional segment consists of our brokerage businesses that service institutional customers, including fixed income, sales and trading, public and corporate finance, equity and portfolio trading, as well as stock loans. Pretax for this segment was up 118% for the quarter, as the fixed income units and stock loan improved.

Both taxable and municipal commissions improved dramatically as volatility and a more normalized yield curve helped increase volume. We kept taxable inventories light in the quarter, but selectively invested in municipal auction rate bonds in the quarter due to the attractive yields. This investment led to the increase in our short-term borrowings on the balance sheet and to an increase of almost $600,000 in net interest revenue for the municipal business unit.

Stock loan drove the rest of the increase in net interest revenue and was a substantial contributor to the profits for this segment in the quarter. The equity side of the institutional business was down versus last year due to the decline in trades processed in portfolio trading, and the absence of any large transactions in corporate finance. The Bank segment produced an increase in net revenue of 13%. However, the $676,000 loan loss allowance, higher compensation costs, and increased cost of REO properties reduced pretax income by 16%.

The sale of the bank's factoring division also contributed to the bank's improved revenue. John Holt will provide additional color on the banking environment a little later in the call. The other segment includes corporate investment, as well as the unallocated corporate administration expenses. This is where we recorded the prior years change in values of NYX, the results of our venture capital investments, as well as the administrative costs of accounting, legal, and other corporate shared services.

Primary changes this year over last year include reduced income from our deferred compensation plan as well as increase in legal fees for the quarter. Lastly, I would like to discuss a few operating statistics. Tickets processed increased 11% from the immediately preceding quarter, as well as the large increase from last year. We finally hit the 100 mark for our PCG wrap. This increase contributed to the overall increase in employee count, which is up 50 from last year. The bank was the other driver of the headcount increase.

Our next slide presents average loans, deposits, and capital balances at the bank. We also highlight the amount of deposits provided to the bank by brokerage customers which averaged $828 million in the third quarter versus $655 million last year. Our reserve to loan ratio is 74 basis points, while our percentage of nonperforming assets to total assets is up to 2.28%. Net charge-offs were $177,000 during the quarter. As nonperforming loans move to foreclosure status, we require updated appraisals and estimates of selling costs on the properties. This determines the chargeoff amount that reduces our loan loss allowance.

At the end of the period we updated our loan loss allowance computation to determine the amount needed to state the reserve at an appropriate level, which is what generates the loan loss provision that hits the income statement. In March '08, the March '08 quarter, the provision for loan loss allowance was $676,000. Our net interest spread in the quarter was down 83 basis points from last March, as the repricing of our deposits from Fed rate changes lags the repricing of our loans.

I would like to now turn it over to John Holt, the CEO of Southwest Securities, FSB.

John Holt

Thanks, Ken. I would like to update our listeners on the bank's results and our three primary lines of business.

Those three primary lines of business being commercial banking, which includes our SBA lending, as well as our residential mortgage lending; number two, our residential construction lending; and third, the mortgage purchase program. I am pleased to report strong growth during the third quarter, up 11.1% for the linked quarter and 34% year-over-year. However, the gains associated with strong loan growth have been initially offset by reductions in the banks net interest margin.

The minimum growth of the net interest revenue is due primarily to margin compression, as reduced interest rates affect the bank's floating rate loans immediately, while deposits from brokerage customers reprice downward more slowly. The bank divested the assets of its factoring department, which was considered a non-core line of business within our commercial banking unit, but also aligns our focus on primarily controlled loan growth and regional expansion.

Additionally, we purchased a seasoned $30 million SBA portfolio, which Don mentioned earlier, which provides accretive returns immediately to this business unit. We continue to evaluate attractive opportunities to purchase portfolios or hire experienced bankers within our three primary lines of business. I'm also pleased to have hired our new Chief Operating Officer, Jerry Pavlas, who brings to the bank over 30 years of executive management and leadership experience and regional banking institutions.

Marginal loan growth in the residential construction area is indicative of the current residential housing market in the North Texas area. Currently there exists a three-month supply of finished vacant homes in the North Texas area, which is above the equilibrium of two to two and a half months supply. We still anticipate continued deterioration in the banks residential construction portfolio, and we have increased our allowance accordingly.

We are committed to this line of business but maintain a prudent approach to managing this portfolio, given the current market environment. Mortgage purchase lending is continuing to be an area experiencing consistent controlled growth, with average outstandings up 32% for the linked quarter and 176% annually. Record fundings in this department exceeded 1.8 billion which was in excess of 9,500 filed.

Due to our increase in fundings and average outstandings, we have hired an experienced senior credit manager with responsibilities for oversight of the portfolio and collateral material. Despite the temporary volatility in the secondary residential mortgage market, we operate only on a flow basis, thereby funding individual mortgage purchases with forward-sell commitments to internally approved investors.

In closing, I'm pleased with the bank's loan growth and implementation of our recently hired SBA team. We are well-positioned to expand our presence regionally across Texas and the Southwest, and are currently targeting experienced bankers in these markets. Don?

Don Hultgren

Okay. Thank you, John. (Operator Instructions).

Let me first focus on our market position. For those of you that have been growing with us over the past few years, you do understand that we have divested quite a few businesses, and we feel now that we are focused on three battles that we can certainly win; and we are excited about the opportunity to do that. We are currently the largest brokerage firm headquartered in the Southwest. We are the largest broker bank headquartered in the Southwest.

Let me digress here. The broker bank model is something to which we were attracted early. It was not common to have banks owned by brokers, and the synergies were not obvious. We think the synergies now have become obvious as we are seeing many other regional firms begin to enter the banking business. So we do believe that that is an endorsement of the model that we have used for quite a few years now.

Finally, we are one of the largest Clearing firms in the United States, based on our number of clients. So what is our strategy in order to grow the firm is to win those three battles. We need to grow the broker dealer; we need to grow the bank; and we need to grow the Clearing business. From the broker dealer standpoint, we offer a tremendous alternative for the investment professionals that are in the Retail space.

We provide them a platform from which they can best service their clients in a manner that see appropriate. If they choose to do transactional business, or if they choose to do fee-based business, or if they choose to just focus on one particular type of product, all such business strategies are welcome at our Retail platforms and in fact are encouraged, as we believe the broker knows what is in the best interest of their customer.

The addition of M.L. Stern is a significant step for us growing the broker dealer. But we also have three in-house recruiters working to grow our private client group and SWS Financial. But it is not just Retail, as I talked before, we have been aggressively growing our Institutional ranks of bankers, sales people, and traders. We will continue to try to add brokers and we will continue to look for additional opportunities similar to the M.L. Stern opportunity.

In terms of growing the bank, we may now be in a better environment to grow the bank than we have been in the past. In the past, we competed with de novo banks, which offered equity interest to bankers to come to their platforms with the anticipation that there would be a liquidity event in a number of years. De novo banks don't look quite so attractive today. In fact, our balance sheet probably looks far more attractive, and as I mentioned I couldn't be more happy with the depth and the energy of the management team at the bank, as they embark and continue to look for additional bankers.

Finally growing the Clearing business, we've talked about this many times. This is a tremendous opportunity for us from the standpoint that we do have excess capacity; and as we fill the capacity, it drops significant margins to the shareholders. So we need to find more revenues for Clearing. We need to do that by finding more customers. We need to do that by doing more business with the customers that we have. We need to do that by finding an acquisition if we can.

Again, we're happy with how the M.L. Stern transaction has turned out, and we are very anxious to be in the market for acquisitions in the Clearing, banking, or the brokerage side of the business. As, you know, on the Clearing side we have invested in new management, and I expect that we'll begin to announce a number of new professionals that are going to be joining the Clearing team in the very near term. So we will grow the brokerage firm, we will grow the bank, and we will grow the Clearing business. These are three opportunities, three battles that we can win, and I think we have the strategies and the people in place to get that done.

In closing, we are excited about what we're doing here at SWS Group. As I said, we have the strategies and the people to achieve our objectives of growth. Thank you to our employees, who go above and beyond the call of duty to help us execute these strategies. SWS Group has great employees, and I am proud to be on their team. Thank you to our customers. You are the reason we are here and we strive to earn your business every day.

Finally, thank you to the shareholders for your confidence and support. I look forward to sharing our progress with you in upcoming quarters.

With that, we'll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Edward Hemmelgarn, Shaker Investments.

Edward Hemmelgarn - Shaker Investments

Yes, just I had couple of questions. One is, can you describe or give us a little bit more guidance as to what might be the financial impact of the Stern acquisition for the next quarter?

Don Hultgren

What we have said in the past is that we thought, as we begin to do the transition of them on to our platform, we thought it would be dilutive to the tune of about $0.06 a share. We have not started that transition yet. We are still, as I said, we work very hard on retention of the brokers. So we would expect to see some dilution over a two quarter time frame. I would guess that might start showing up in the first quarter, Ken?

Ken Hanks

In the first quarter.

Don Hultgren

Yes.

Edward Hemmelgarn - Shaker Investments

So, I mean, this quarter or the first quarter means, first quarter of your next fiscal year?

Ken Hanks

The September quarter, which would be the first quarter of our next fiscal year, is the most likely place to part of it will show, and then the rest of it will show in the second quarter of next year.

Edward Hemmelgarn - Shaker Investments

Okay. So it's not $0.06 a quarter but it'll just be $0.06 spread over the first and second quarters?

Ken Hanks

Correct.

Edward Hemmelgarn - Shaker Investments

Okay, okay. When do you expect to see more of a positive impact to start?

Don Hultgren

I would expect that to begin in the second half of next fiscal year.

Edward Hemmelgarn - Shaker Investments

Okay. I'm curious why there wouldn't be more of an impact or why you would wait to see the dilutive impact until the first and second quarter of next year. Why wouldn't it show up in the next quarter?

Don Hultgren

Well, if you think about it, a lot of the costs associated with the conversion are going to occur after the conversion occurs. So, our next step is to get M.L. Stern converted to our platform. In the meantime, we still need to have contracts with all of their vendors, and all of the general things in place, for that conversion, so any of the costs streamlining won't show up until after the conversion has taken place.

Edward Hemmelgarn - Shaker Investments

Okay. Do you expect any -- I mean, you are talking about the dilutive impact of -- so basically in this quarter, the impact is essentially neutral?

Don Hultgren

In the current quarter, I mean it's whatever they do. I mean they are profitable and so.

Edward Hemmelgarn - Shaker Investments

I guess that's what I'm trying to do is get an idea I mean of can you give us some guidance as to what kind of an impact at their current run rate is?

Don Hultgren

I don't think that, we don't normally break that out by division. But I would tell you that the M.L. Stern subsidiary itself is profitable, and I'm expecting it to have some positive impact on the fourth quarter.

Edward Hemmelgarn - Shaker Investments

Okay. Any thought, I mean as a largest brokerage firm in the Southwest, obviously, you've tried to improve your position in the municipal market. The other I guess, major market would be the more typical, certainly the Texas area and so forth would be the oil and gas market, any thoughts about trying to do an acquisition in that area?

Don Hultgren

Well actually, the way we look at the M.L. Stern partnership is that it's a private client group partnership. Their private client group happens to do more municipal business than ours. So as opposed to really being a sector play, this was an effort to expand our PCG effort. If you take a look at a map, what we would like to see is a footprint for us that would go from Texas to Kansas City and all the way West. We'd be very interested in any private client group operations that might be in there.

Ken Hanks

Yes. Can I add something to that, Don?

Don Hultgren

Please.

Ken Hanks

Some of our plans do include in the next 12 months expanding the presence in Texas as well, which might be considered going after some of the oil and gas, the customers that are receiving the benefits of oil and gas, by expanding our presence in Dallas and our presence in Houston.

Don Hultgren

Yes, that's a good point. Our Houston office has been growing very well, for example, an oil and gas subsidiary or anything like that.

Edward Hemmelgarn - Shaker Investments

So your principal focus is just going to be on growing the private client group?

Don Hultgren

Well it's not just Retail. I'm looking at some of the fixed income guys who are getting ready to jump on here. We are growing both the Retail and the institutional sides of our business. The only business that we're not in is institutional research equity and trading. Otherwise, we continue to look for brokers, both private client group and independent contractor. But we also are looking for brokers and traders on the institutional side as well. But private client group it's a little easier because it's easier to define. Our Institutional business is all over the country.

Edward Hemmelgarn - Shaker Investments

Okay. Great. Thanks.

Don Hultgren

Great. Thank you.

Operator

Erin Caddell, Hovde.

Ken Hanks

Erin, how are you?

Erin Caddell - Hovde

Hi. Can you hear me, okay.

Ken Hanks

We can.

Erin Caddell - Hovde

Just a couple things, first of all, maybe you said this, Ken, in your prepared remarks. But was the DTCC refund in the quarter?

Ken Hanks

Well, I don't think I actually said the amount; but it's about $2 million.

Erin Caddell - Hovde

Okay, thanks. And then, I just look in to the Q this morning, you said that, maybe you're still allocating the purchase price. But, what's the equity and the goodwill and other intangibles from M.L. Stern?

Ken Hanks

We don't have that yet. We've hired a third-party firm to help us with the purchase accounting on the transaction. And that will be something that comes out in this next quarter.

Erin Caddell - Hovde

Okay. And then, can you just give a little more color, Don, on kind of the tenure of the brokers there, the average productivity, maybe just a little bit more about who these folks are that are coming on board?

Don Hultgren

That's a great question, because it's one I want to answer. The group out at M.L. Stern has quite a bit of experience. I was absolutely amazed at how many reps they had that have been with them for over 10 years, many reps have been with them for over 20 years. It's an interesting model. It is a little different from the standpoint that they actually train brokers. And a lot of the guys who are there never worked anywhere else, which may have helped on the retention side.

What we're seeing as far as production is very similar, about 350 to what we have. So, all in all, it's quite a culture fit. There are people, similar to Southwest Securities that have been part of that organization for a very long time. I believe the culture is that enabled this to occur. It's a great fit.

Erin Caddell - Hovde

Okay. Great. Well, thanks for those answers, and congratulations on a good quarter.

Don Hultgren

Thanks, Erin.

Operator

Tripti Prasad, Sidoti.

Don Hultgren

Morning, Tripti?

Tripti Prasad - Sidoti

Good morning. Just to quickly recap on the M.L. Stern acquisition. Are these lower at profit margin sort of brokers? I think on average we're running between 13% and 17% on the Retail side now. Are these lower maybe 10% to 15% given fixed income focus?

Ken Hanks

That's a good question, Tripti. I don't believe so. I think they are very similar they will end up being very similar to our current Retail mix. I think the difference that will be is once we have the new Retail segment will basically be reported on for the first time in the fourth quarter.

Tripti Prasad - Sidoti

Okay.

Ken Hanks

Right now, if you look at that segment, you have about 50% of the revenue coming from private client group brokers and 50% of the segment coming from independent contractors. When you reconfigure it to include the M.L. Stern transaction, you are going to have like two-thirds of it coming from private client group brokers and only a third coming from the independent contractors.

I think there will be a slight change in the profit margins. I'm not sure that that will really completely shake out to where we know what the real run rate will be till sometime in 2009, after we have all of the conversion and transition costs wrung out of it.

Tripti Prasad - Sidoti

Okay. So essentially nets out, and given that I think at that point you will have roughly 210 on the private client side, and 320 correspondents on the independent side, they typically run about a third of profitability?

Ken Hanks

Right. So at that time once we're through all of that, I think a 15%, 13% to 17%, somewhere in that range is going to be your segment profitability.

Tripti Prasad - Sidoti

Okay. And then if we could just, and you might have said this and I'm sorry. So I am looking at on average about 11 less reps per hedged across the board. But $60 million increase in brokerage balances, in the deposits that were interest bearing. Could you just say in a down-market how that works?

Don Hultgren

Are you talking about the interest bearing deposits at the bank?

Tripti Prasad - Sidoti

Yes, is that a sweep or how does that work?

Don Hultgren

Yes, it's a sweep. A lot of that can happen because today that's our default sweep when we get a new customer. So let's say, we lose a broker and we hire a broker, the old broker may not have had their stuff deposit over to the bank; a new broker will. So it's not really a function of the market, and it can be a function of just how many new accounts you have.

Ken Hanks

While this is anecdotal evidence, Tripti, there has been in the last quarter, maybe even two quarters, a lot more interest in an FDIC insured product than there has been in the past, with the instability in the financial market.

Tripti Prasad - Sidoti

Right.

Ken Hanks

So we have a lot of people that we'll adjust in the money market fund; they started reading about the fact that some of the money market funds have SIVs and CDOs; and they moved their money out of the money market funds into the bank, as much as they could.

Tripti Prasad - Sidoti

Okay. And then finally, a last question for John, looking at the nonperforming assets. Can you just provide some sort of in-parent, what type of loans are traditionally or in this quarter had been rolled into nonperforming?

John Holt

It is primarily in the area of residential construction. So I anticipate over the next couple of quarters, where we can't predict with any certainty, they would be similar to the last couple of quarters. Even though the chargeoffs were certainly lower in this quarter, we did do some reserves.

Tripti Prasad - Sidoti

Okay. Thank you very much.

Don Hultgren

Thank you, Tripti.

Operator

(Operator Instructions). At this time there are no further questions.

Don Hultgren

Okay. Well, I thank you all very much for joining us today. We appreciate your interest. We appreciate your support. We look forward to talking to you next quarter. Have a great day.

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Source: SWS Group Inc. F3Q08 (Qtr End 03/28/08) Earnings Call Transcript
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