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Executives

Jeremy Skule – VP, IR

Kevin Davis – CEO

Randy MacDonald – CFO

Don Galante [ph] – Chief Investment Officer

Henry Campbell [ph]

Analysts

Howard Chen – Credit Suisse

Ken Worthington – JP Morgan

Alex Cram [ph] – Lehman Brothers

Don Fandetti – Citigroup

Rob Rutschow – Deutsche Bank

Rich Repetto – Sandler O’Neill

Niamh Alexander – KBW

Jonathan Casteleyn – Wachovia Securities

Mike Carrier – UBS

Mike Vinciquerra – BMO Capital Market

MF Global Limited (MF) F1Q09 (Qtr End 06/30/08) Earnings Call Transcript August 7, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fiscal first quarter 2009 MF Global earnings conference call. My name is Tina, and I will be your conference coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference call. I will now like to turn the presentation over to your host for today’s conference, Mr. Jeremy Skule, Vice President of Investor Relations. Please proceed, sir.

Jeremy Skule

Good morning, and thank you for joining MF Global’s fiscal first quarter call. With us today are Kevin Davis, CEO; Randy MacDonald, CFO; and, Don Galante [ph], our Chief Investment Officer.

This conference call is being recorded on behalf of MF Global and consists of copyrighted materials. It may not be recorded, reproduced, retransmitted, rebroadcast, downloaded, or otherwise used without MF Global’s expressed written permission. This information made available on this conference call contains certain forward-looking statements that reflect MF Global’s view of future events and financial performance as of June 30, 2008. Any such forward-looking statements are subject to risks and uncertainties indicated from time-to-time in the company’s SEC filings. Therefore, the company’s future results of operations could differ materially from historical results or current expectations as more formally discussed in our SEC filings. The company does not undertake any obligation to update publicly any forward-looking statements.

The information made available also includes certain non-GAAP financial measures as defined under the SEC rules. The reconciliation of these measures is included in the company’s earnings release, which can be found on the Web site and in the current 8K furnished to the SEC in advance of this call.

With that, I’ll turn it over to Kevin.

Kevin Davis

Thank you very much, Jeremy. Good morning. Thank you all for joining us today on our first fiscal quarter call. I would like to share with you today an overview of our capital plan, business highlights in the first quarter, and our focus areas going forward. Randy will then address the financials in more detail.

MF Global has made significant progress over these past six months to ensure our long term financial stability, and position the company for future success. We’ve completed our capital plan, strengthened our balance sheet, and completed our risk review, all of which support our recently confirmed investment grade ratings.

Let me start off today on slide three by briefly reviewing our recent refinancing. As you know, we recently finalized the complex refinancing of the $1.4 billion (inaudible) loan facility, which was put in place as part of our spin-off from Man Group. To recap what we have done, the refinancing involved multiple transactions, including establishing new longer term bank credit facilities, applying excess funds held by the company, issuing convertible debt and preferred equity, and applied (inaudible) whose involvement, I would add, represents a significant vote of confidence in our future from a highly respected financial institution.

We should also note, as part of the (inaudible) our regulators have approved a release of more than $270 million in regulatory capital, which we see as an additional vote of confidence in the strength of our balance sheet and our company. Collectively, these steps insured that we preserved our investment grade credit ratings and maintained our franchise. Importantly, all three of the major credit rating agencies have removed MF Global from negative lot, and the outlook for the company is now stable.

Looking at our first quarter on slide four, we provided some of the key matrices, which are in line with our update from mid June. Our volumes were up 17% year-over-year to 550 million lots. Our volume growth was primarily driven by strong performance in our professional trader segment as well as increases in our interest rates futures businesses.

Although net revenues were flat year-over-year, this is further evidence of the strength of our diversified business model. Let me explain why. We made significant changes to our CFD business in Europe to strengthen our overall balance sheet, the byproduct of which was a negative impact on our net revenues. We also experienced decline in our net interest income. Thus, the fact that our net revenues remained unchanged reflect the diversity of our business as well as the focus and dedication of our employees, who have worked diligently with our clients to take advantage of the secular trends within this industry.

EBITDA was down year-over-year, primarily as a result of high long comp expenses, specifically, professional fees and communications and technology, as we indicated in our June announcement. I would remind our investors that during the same period last year, we were still part of Man Group and our expenses didn’t yet reflect what was to be our top public company run rate. Earnings per share of $0.29 were down year-over-year as our business mix changed. We experienced high long comp expenses, our share counts increased, as is interest on borrowing. This was partially offset by a lower tax rate. We believe these numbers demonstrate that our franchise is well positioned to deliver results for our shareholders.

Slide five demonstrates per value and the diversity of our franchise. As you can see, our portfolio business has largely offset the decline in interest income. Our transaction based net revenues grew $10 million. And matched principal was flat. And our US fixed income business growth largely offset declines in our CFD revenues. And our other net revenues, primarily from commissions associated with matched principal businesses, collectively helped us to offset the $19 million decline we experienced in interest income from the investments plan advance.

On slide six, you can again see the benefits of our diversified model. In about the two largest global exchanges experienced slow growth in the quarter, we were actually able to significantly increase transactional volumes. It’s worth noticing that the energy exchanges, specifically non-Exonized [ph], were beneficiaries of significant volatility in their market. Whilst we also benefited from heightened activity in this space, it represents a small overall proportion of our business.

Our dialogue with our customers has been continuous to be good. Many of our largest clients have expressed support, and our relationships remain sound. In speaking with our clients, there has no doubt been some evidence of the leveraging of some of our customers’ segments. However, these trends have been largely offset by customers’ ever increasing demand for central clearing counterparties barring independent and unconstrictive broker.

Whilst timed efforts are up from fourth quarter 2008 to first quarter 2009, this did not reflect the surge in new client relationships. We are deliberately focusing on higher margin client relationships, which may not necessarily translate into higher client funds. As evidenced this quarter, client funds are not directly tied to client retention, attrition, or acquisition that can be influenced by any number of factors including the absent (inaudible) exchange margin requirements and/or customer’s market-to-market gains and losses.

As mentioned in today’s announcement, we have effectively closed the risk review associated with the February weak trading incident. However, in order to ensure that we continue to invest in class, risk practices, and procedures, we are continuing our risk review globally.

As we look ahead on slide seven, we are in intent on delivering industry leading service, execution, and ultimately, financial results. We expect to achieve this by focusing on our key assets. The most important of which is our people. Secondly, we continue to seek to enhance systems and focus on high growth and high margin errors to improve our performance. Finally, we continue to execute and improve upon our strategic plans for growth.

Turning to people, we have some of the best and brightest people in this industry. We know that in order to maintain our leadership, we need to continually build upon our existing world-class organization and culture. Improving our ability to attract and retain key talent in the industry increases our ability to win new clients and to expand into new and existing high margin lines of business. With the right teams in place, we continue to improve our performance by building upon the company’s competitive strength. For example, we are truly independent and free of conflict. As an independent broker, we are able to deliver unmatched and unbiased insight into the futures, options, OTC, and cash markets, in which we operate. Clearly, our insight is derived from our long standing position as a leading broker in many of the markets in which we serve.

As a uniquely diversified global franchise with a commanding presence in critical markets, we’ve been able to leverage the secular trends occurring in the industry, including a convergence of asset classes and a democratization of financial markets globally. These qualities create clear advantages and momentum in the marketplace, and reflect our long term strength as a business and as an investment. In addition, we are working to insure that we maintain best in class risk and compliance systems instructors to enhance our franchise. We continue to examine every opportunity to examine – to enhance our risk systems and processes globally. And as part of that effort, have enlisted leading consultants to further advise us in that regard. Overall, we remained focus on improving our top line growth, enhancing expense controls, and delivering higher margins.

We have developed a growth strategy to accomplish this. Our plans remained focus on the high growth, high margin opportunities in OTC, retail, and Asia Pacific. We continue to complement our existing platform to enhance service and product offerings. A good example of this is the rollout of our online FX platform, which is gaining traction in Asia. Additionally, by expanding OTC’s percentage of our overall business, we’re able to leverage the higher margins associated with those businesses. We are already looking at several ways of expanding these areas. For example, in our energy business, we continue to remain at the forefront of the convergence of OTC and futures liquidity pools. We recently recruited a highly experienced sales team in the OTC distillate products segment to augment our NYMEX, futures, and options product teams. And have expanded our commitment to rapidly grow in green energy markets, such as carbon gas emissions and renewable energy.

We’ll also achieve overall growth in the rapidly growing Asia Pacific region, which has recently increased from 8% of our business to 12%. Japan, Taiwan, and Korea in particular have rapidly developing futures and options markets, in which we’ll seek to recruit key teams and make acquisitions where possible to expand our presence in the region. One way in which we’re growing here is through actively participating in a number of initiatives to develop new commodities and financial exchanges in Asia, including those in Hong Kong, Singapore, and India, and ultimately, of course, China. Also in India, we recently became the first broker licensed to offer newly sanctioned direct market access facilities. We hope to have more news on the Asia Pacific funds in the coming months.

With a global view, we also take advantage of the potential industry consolidations by looking to acquire businesses that fit strategically and meet our criteria to increase product depth, expand our geographic presence, and diversify client channels, all of which we expect to derive earnings growth.

Before I turn the call over to Randy, let me say how deeply we appreciate your support to what turned out to be a very challenging period. As I said previously, over the last several months, we’ve completed our capital plan, strengthened our balance sheet, completed our risk review, and confirmed our investment grade rate. Having all of these is a testament to our franchise and to the hard work and dedication of our global teams. I look forward to the challenges that lie ahead. And I’m confident that we are well positioned to meet them. And with that, I’d like to turn the call over to Randy, Randy.

Randy MacDonald

Okay. Thank you, Kevin. Two quarters ago, we started this journey of greater transparency on the business model. We did that by disclosing (inaudible) transactions. And then last quarter, we added the yield and the balances for net interest income. So this journey will continue, and it looks like a few quarters. But as a next step in that journey and certainly in the spirit of providing greater insight on how we think about this business model, therefore, the greater transparency, we’ve created this new single page to view net revenues.

I think Kevin made a great point that in spite of some pretty horrendous market conditions, and given that we had $18 million year-over-year decrease in our net interest on the client funds invested, MF’s underlying businesses grew. Now this slide shows the miniature components of those revenues in the same way that we tend to think about them. So for comparison purposes, you may want to refer to the next slide, which is number nine because that’s the same quarter last year. But I’m going to walk you through this slide. And I’m going to go through the three areas pretty slowly to make sure everybody understands.

So interest income is in rows one through three, and columns E through I. And then, principal transactions, that’s in row four, and it goes through columns E through G. And then you have commissions, rows five through eight, and columns B through D. So let me now navigate you across the top of the slide and the four sections.

The first section, what that does is it reconciles you back to the GAAP amounts that we reported. The second section includes columns B, C, and D. That’s our commissions business. And so, columns B and C, those are the futures and options businesses that are traded on the exchanges. Column B, those are the commission trades that are earned on trades away from the exchanges. So at row 13, you’ll note, although there are 21 million lots that are associated with some of these commissions, I’m going to tell you there are many more of these commissions that don’t have standard units of measure. So a yield per unit of measure is not calculated because it just wouldn’t be meaningful.

The third section is our matched principal business, and it includes the securities lending, which is column E; the fixed income or our matched book business, which is column F; and then, the matched book matched principal trade column, which is G. And then lastly, we have the fourth section, column H is the net interest earned on the clients funds invested. And then column I is the return on MF’s own Capital with debt and equity.

So now, going to the vertical axis and the first three rows, that shows the gross interest income and expense. And then the net of those two or $107 million is the net interest earned this quarter. And then, that amount is the sum of the interest in columns E, F, H, and I were the net interest is attributable.

So let’s start with the fourth section, and in column H, there’s the $53.8 million in this quarter, which was $19 million less than in the same quarter last year. So the average balance in row four, with $16.4 billion, were only 4% lower than the same quarter last year.

At balances, they could be impacted by a variety of exogenous things, including changes in margin requirements at the exchanges, a market volatility, declining asset values as we’ve recently seen or recently seen in the energy markets, as well as the composition of the margin. And what I mean by that is the composition – as the clients can elect to deposit securities this margin. So in that case, those securities are not carried on our balance sheet. Now notice that as a result of these exogenous factors, client funds can fluctuate daily. And I would say one should not assume that the balances report would be indicative of future balances.

Now, looking at the interest yield of 1.33% on line 15, it was significantly lower than the same quarter last year. Now, you remember, after the weak trading incident MF experienced in late February, we had strategically shifted the portfolio of client funds investor trunk [ph] at approximate average duration of 60 days to effectively overnight. So this meant we began to loose some spread and in the latter part of negative Federal Reserve open to discount window to US investment banks. Now what this did is to create a flood of short term treasuries onto the market. And then that in turn dramatically increased yields in the 30 to 90-day T-bills, which is the rate we typically pay on our non-retail clients for the funds they keep with us.

Now, as mentioned in our previous press release, there was a fairly sudden narrowing of spread between what MF pays its clients on their margin deposits and what we earn on those funds. And the rate on row 15 of 1.33% was 39 basis points lower than the same quarter last year, resulting at significant loss of spread. Now in these columns, at the very bottom mid section, I presented you with the average balances and the corresponding yields.

So now, we’re, again, affirmed by all three of the rating agencies. We’re taking a measured approach to now extending the duration in our client funds invested to try and achieve greater net interest income. And as we extend the duration, we’re maintaining that high quality liquid assets and keeping the opportunity to enhance yield.

Now, let’s take a look at row four, which is principal transactions, we stated previously that the best way to analyze principal transaction revenue is to combine it with the net interest that it’s generated from those transactions. So we now look at columns E, F, and G, you remember, Kevin spoke about realigning the CFD business. And parts of this business roll up into each of these columns. So naturally, the net revenues decline as a result of this realignment and retooling of the balance sheet. So looking at column E stock lending, this was mostly the result of realigning the CFD business in Europe, plus falling interest rates. And compared to the same quarter last year, the average balances are down, yields are down, so the net interest income was $10 million lower.

Column F, that’s the fixed income business that saw a healthy increase in business. Balances were cut nearly in half, yet the interest income nearly tripled from a year ago to $32 million this quarter. The yields row 15 increased considerably to 1.12%. Now I’ll discuss this in greater detail on some coming slides. However, it’s a snap shock when you say that MF’s fixed income business saw wider spreads as there was a disconnect in the credit markets, which provided opportunities for our independent broker model.

Rolling up in column G would be energy, metals, agriculture, and ForEx. Now, metals and ForEx were down due to lower volatility and narrow spreads. However, energy saw a nice increase in its business as many other product areas experienced increased volatility. Again, what all these highlights is the diversity in the balance of MF Global’s model. So in summary, we’re $10 million down in the CFD and the securities lending business. We were down $10 million in principal transactions. But we’re up $20 million in our fixed income business. So looking at row 12, column F, in aggregate, our diversified business model meant that we were essentially flat from the same quarter last year at $100 million.

So now, moving to rows five through eight, row five includes where we only execute for clients. Row six is where clients are both executing and clearing with MF. And so this would also include introducing brokers who cleared their business with us. And then row seven – also the execution fees to this business. So they would be deducted from rows five and six. And then on row 11, column B, if you look at the year-over-year net execution and commissions, they increased 8% to $91 million. Now that increase came mostly from higher volumes and strong performance in the interest rate product business. Then in column B, row 15, the execution only yields were $0.60 per transaction this quarter, a $1.07 lower in the same quarter last year.

So with mix shifts, there’s always going to be in these yields. But this quarter, the primary reason for the decrease was the shift in NYMEX trades from floor-based to spring-based executions. And although there’s less yield per trade, these are low-touch, less expensive trades. In column C, row 11, you see that year-over-year, the net cleared commissions, though, they increased 1% to $145 million. And this was driven by higher volumes in our professional trader segment.

The yield from clearing, which is row 15 was $0.38 this quarter, which was $0.05 lower than the same quarter last year. And again, with mix shifts, they’re always going to be change in these yields, but yes, fluctuations they naturally occur as the mix of customers, to products, to geography change. This quarter, we experienced a shift towards more professional trader business, which again, is lower touch, lower cost. But this trend was also accentuated by the recent acquisition of our online broker in Australia, broker one.

Now, the next row is row nine. The sales commissions of $67.7 million are paid introducing brokers to bring their clearing business to MF. And then, row 10, other income of $11.6 million is mostly ancillary services, which we provide the clients, things like (inaudible), facilities fees, screen rentals, and the like. So in summary, how did this mix of revenues look relative to fiscal year ’08, well, let’s go to the next slide, which is actually slide ten.

Now, market conditions one year ago were not great. But one year later, the world is completely different. So after all these turmoil, how did our diversified model prove out? If you look on the right side, the commission revenues in green increased to 51% in net revenues. And then, the matched principal revenues in blue increased to 20% in net revenues. While the net interest income from client funds declined by five points to 19%. So this is another way of thinking about the waterfalls slide that Kevin presented, which again proves the balance and diversification of the business model under some pretty trying times.

But now, let’s look at how we view our simplified income statement, which is slide 11. And the net revenues, we just carry those over from the previous slides. And I want to remind you that the March quarter was the best quarter in the firm’s history. On a year-over-year basis, compensation expense was down both on an absolute and as a percentage of net revenues. So this resulted in some operating leverage as the percentage was down nearly 300 basis points. Now comparing it to the March quarter, one might expect that compensation will move in a linear basis. However, because we clearly don’t include most of that net interest income in paying producers, and because the commissions and the principal transactions were a greater percentage in net revenues this quarter, it would be expected that the compensation as a percentage of net revenues would be higher this quarter.

Now, the non-comp expenses are running at the approximate levels that we thought they would. Comparing it year-over-year, the non-comp expenses increased $17 million, which again was to be expected, as last year, at this time, MF was not a public company. So the new public company has costs associated with legal, regulatory, and obligate enhanced financial reporting, increased insurance cost. Now, non-comp expenses are down significantly from the March quarter, and they’re key major in the March quarter. One was the CFTC find, which was $10 million. And then we have the foreign exchange translation laws of the subsidiaries, and that was a swing of about $7 million, swung from a loss last quarter to a gain in this quarter.

And the same is true for the debt structure as the interest expense a year ago was based on the IPO debt structure. So given the higher non-comp expenses, pre-tax margins were lower year-over-year at 14%. Now tax rate, that is particularly favorable this quarter as the mix of income shifted. Now, we expect the full year to be closer at 31% on effective rate basis unless this mix of business continues. In summary, EPS for the first fiscal quarter was $0.29. So year-over-year that was a decline of 24%, and it primarily came from five things, the revenue mix shift, which was offset by compensation; the $17 million increase in non-comp expenses; the increase in the interest non-borrowings; slightly higher share count, and then that was partially offset by our lower tax rate.

So now, let’s turn to the balance sheet. That’ll be slide 12. Now, we’ve continued to de-lever the balance sheet as we’ve realigned the CFD business, bring it down another $5 billion this quarter, and 30% over the last six months. Now, we’ve continually executed the strategy for shifting MF’s balance sheet to be a more liquid balance sheet. Now, this balance sheet compares to changes from the March quarter to the June quarter. And this change is primarily a result of reshaping our fixed income and the matched book for more efficiency of yields. We summarized our balance sheet into those assets and those liabilities related to clients or what we call key businesses.

Now, in the final stages of our FAS 157 review, and I would say, at this point, the only level three assets or liabilities that we have on this balance sheet are approximately $18 million in exchange seats and shares. And so that would mean that more than 99.9% of our balance sheet are either level one or two.

At June 30th, MF had $43.6 billion of liquid assets, versus $41 billion of liabilities. Now, we’ll see on the next two pages how these changes impacted liquidity. One thing that is new is the second line of the balance sheet. So to report more in line with the way the business operates, we’ve reclassified some accounts. The restricted cash and the segregated securities now includes both restricted cash as well as securities and reverse repos where the security or the underlying collateral is held in accounts segregated under CFTC’s specific segregation rules. So you note that this segregated account is now the largest asset on our balance sheet.

So let’s take a look at how we did handle client liquidity this quarter, and turn to slide 13. Now, you may remember this from last quarter, the top cap of the balance sheet is simply taking the previous slide and re-ordering it, so all client driven activities at the top half. And then, the client activity determines the amount and timing of the cash flow and the balance sheet. The bottom half of the balance sheet is then how we utilize those funds. So we ensure these funds are liquid, they’re safe, they are high credit quality instruments. So the increase in the March quarter was $300 million, which were the proceeds from the CFD and the senior notes. And we had to just take down the capital less June 30th. That’s why they’re still there.

A number of you have asked how much of our equity capital is liquid and whether we have enough headroom to grow, and also, have we increased our capital structure. So the next slide should help you understand the answers to those questions. So let’s take a look at that. That’s slide 14. When we take the liquid assets of $43.6 billion from slide 12, and then we net off those liquid liabilities on the same slide at $40.9 billion, we get $2.6 billion. Now, if we remove all the debt from the balance sheet of $1.8 million, which includes taking that $300 million that we raised in paying down the bridge, then what we’re left with is liquid equity at $793 million.

Now, if that – if the excess capital is an amount that’s smaller than liquid equity, then all the excess capital is invested in net liquid assets, and it’s available for distribution. Now, we estimate that the excess is about $0.5 billion. This excess capital is available for spikes in client activity. And that’s what allows us the headroom to grow. The company’s capital base of $2.9 million has remained essentially the same. However, we now have less debt, and then the debt is longer term, and then there’s more equity.

Now, turning back to the matched broker to reverse repo business, let’s turn to slides 15 and 16. I told you earlier that I speak specifically to this reverse repo business. And one of the key businesses in our yield enhancement strategy is this reverse repo business. And the mechanisms for reverse repo business are very, very similar to our futures business. And our transactions are client driven, and they’re managed through the margining process. Now, what we don’t do is use reverse repos to finance the business. A reverse repo book consists of highly rated securities such as treasuries, which are valued on a daily basis.

So there’s minimal counterparty risk as the vast majority of our transactions flow through the fixed income clearing corporation or the FICC. So if you look at the balance sheet on slide 12, the reverse repo books sits at $9.8 billion on the balance sheet at the end of June. And this business is entirely client driven, and it builds off the current competencies of our futures business. And this all relates to this convergence that’s happening between cash and the futures business and the fixed income market. So in another way that is they complement and our – their strong synergies could be realized. So in summary, now that are capital plans’ in place and our investment grade ratings are secured, we’re looking to increase our focus on efficiency risk adjusted returns and to continue to improve the transparency of our business model.

So Kevin, I’m going to turn it back to you for questions.

Kevin Davis

Thank you very much, Randy. We’re ready for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from the line of Howard Chen with Credit Suisse.

Howard Chen – Credit Suisse

Kevin, good morning, Randy.

Randy MacDonald

Good morning.

Kevin Davis

Good morning.

Howard Chen – Credit Suisse

Thanks for taking my questions. Kevin, in the beginning of your prepared remarks you spoke to your business feeling some impact from de-leveraging. Can you discuss what types of customer segments that’s affecting, how you actually determine it’s de-leveraging, and potentially, maybe what’s the magnitude of that on your business?

Kevin Davis

Well, in retail, clearly, de-leveraging happens as margin requirements had generally increased. That’s been clearly the case most starkly in the CFD business where we let the process of raising margins in that space in Europe. But of course, exchanges have generally raised margins. So you would see some impact in transactional volumes from retail. The other area, of course, would be some hedge funds (inaudible) to some de-leveraging, and they don’t have something of a dampening effect. They’re not all horrendous, I should add, on that part of our business. But see as I’ve said, in the other direction, of course, customers are continuing to seek markets with central clearing counterparties, and of course, which is obviously the underlying driving secular trend growth in the industry. And of course, the fact is we have an independent and unconflicted model. So we have seen funds activity abate (inaudible). We’ve also seen how the areas increased.

Howard Chen – Credit Suisse

Great. Thanks. And then, as a follow-up, I’m trying to gauge an earnings run rate going forward. I guess if we start with your adjusted $0.29 per share EPS this quarter, we estimate the financing actions will bring roughly at negative eight cents per share impact on quarterly earnings. Do you agree, Randy, that that $0.21 is a fair starting point going forward? And what do you view – and if so, what do you view is the best potential drivers for growing earnings off that base over the next few quarters and year?

Randy MacDonald

Yes, Howard. We’re not actually being terribly specific about any sort of guidance. I think our job right now is to make the business model as transparent as we can. We certainly can’t predict interest rates and client balances. Those are things that are not in our control. So what is in our control is our relationship with our clients and making sure that we’re providing them with the best product and the best service. So I’m not sure I can fully answer your question.

Howard Chen – Credit Suisse

Okay. Thanks. And then final one, Kevin, with regards to consolidation, I know the company and management has been more inwardly focused in the past few months. But we’ve seen one transaction and the interview of a broker’s space, and a seemingly increased dialogue among that competitive landscape. I’m interested in getting a sense of your company’s level of interest in broadening into the inter-dealer broker space. And is there that same level of strategic dialogue in the FCM business – industry right now? Thanks.

Kevin Davis

Well, as we said time and again, our business does share some characteristics with the inter-dealer space, but there are more differences than there are similarities. Our business is one which revolves around central clearing counterparties, whereas typically, the IDB space is one where it operates on a name key market basis. So I wouldn’t say that our business is sort of converging towards IDBs. It’s (inaudible) wall consolidation. We’ve said a key area of interest for us is Asia Pacific, and we would hope, over the comings months and years, to be in a position to lead consolidation process in that region. There is a great deal more to be done here in the United States or Europe.

Operator

Our next question will come from the line Ken Worthington with JP Morgan.

Ken Worthington – JP Morgan

Hi. Good morning. Maybe first for Kevin, you completed or the risk management review has been completed. Can you tell us a little bit about what changes are being made and how those changes will impact the way you and your customers do business? I’m just trying to get a sense of is there actually an impact to the way business is done.

Kevin Davis

I wouldn’t say that there’s a dramatic impact to the way in which business is done. The recommendations we’ve received from our two world-class consultants have really been about improving the efficiency and effectiveness of our processes and technological controls. And of course, that’s the process that in any circumstance should continue forever. I mean we never stop trying to improve those systems, and that is the case.

Ken Worthington – JP Morgan

Thank you. And then maybe two for Randy, Randy, and I think it’s the appendix page 18 of your presentation. You have a net interest income kind of divided by the client cash produced lending fixed income capital structure. We’d love to better model the net interest income. You definitely gave us some guidance in your prepared remarks. Are there things that we can track because the spread varies quite a bit? I can’t tell what there is because of you getting out of the different products. But for example, client cash, it’s like the difference between treasuries and agencies. If we manage that spread, we’ll probably have an idea of what the spread is in client cash. Other things for securities lending and fixed income that we can track to better gauge how those yields will move around?

Randy MacDonald

Now, I think the harder one is more on the business side and that principal transaction section. But I think you’re right about client funds. I mean it’s certainly client balances. Our capital structure doesn’t fluctuate a lot. So that’s on the balance side. The rate side, as a general rule of thumb, the deposits are, at least for the institutions, are that 30 to 90-day T-bill rate. And then, in this quarter, we were certainly very, very short in terms of duration. And we’ve mentioned that we’re now able to go out and get more spread by extending the duration for those client funds.

But the principal transaction business is literally a business of opportunity. And as you saw this quarter, there was a dramatic shrinking of the institutional CFD business. So that had a fairly negative impact on the quarter. Whereas, the fixed income business enjoyed a lot of opportunity, frankly, dis-intermediating some other folks in the industry. Kevin mentioned that people are coming to us because we are conflict free, and we do understand that there are these conversions between cash fixed income and the futures mixed income. And we have this unique capability. So fixed income guys, I thought, did a very nice job this quarter. And they provided nice balance and balance.

Unfortunately, Ken, I can’t point to anything on the business side that would better help you model that. And certainly, there’s nothing that I can provide on a predictive basis. I’m not seeing anything.

Ken Worthington – JP Morgan

Okay. Worth a try. And then lastly, actually for Randy, how shall we think about the balance sheet over the next 12 to 18 months? You’re generating and we expect you will continue to generate excess cash flow. You’ve got excess capital. Do you continue to use the cash flow to build up the balance sheet? Do you think that you paid down debt? What happens there? And then, on the $270 million of regulatory capital that was released, what exactly does that mean? Does that mean – you just raised $300 million of convertibles. How should we kind of put that in context with the capital raised and the uses of that freed up capital?

Randy MacDonald

Yes. Let me go on reversed order. I’ll make sure I – if I forget to answer one of those, I think, three questions, I’ll – you’ll remind me, right? In reverse order, there is a step function to take you down on the refinancing of the bridge. So we have that slide up on the Web site, I’ll refer you to that slide. But one of the key components was taking excess capital and paying down a portion of the bridge. And that was about $300 million. There is a stub [ph] piece to the bridge of $100 million that is due in December. And we have capital in the UK that we’re waiting for the FSA to due their, what they call their hour review to review our capital, review our business there. And in the fall, we would expect that that capital would be available to them to pay off that remaining $100 million of the bridge.

The other excess capital, in my remarks I mentioned we need headroom. So if client balances do spike, although they basically pay for themselves, that is the – in US, a good example is we need 80% of those balances as regulatory capital. Well those clients between transactions and the net interest income that we earned, if our pretax margins are 15% to 20%, well then they’re actually generating capital to handle that business. But that doesn’t mean at a nanosecond at a point in time there’s a sudden spike that money is immediately there. So that’s why you need excess capital to maintain the growth trajectory of the business, but it is self-funding.

Going back, and I do forget, what the other – can you guys help me? What was the other question? Oh in the size of balance sheet. As I’ve said now for two quarters, that’s really client driven with the exception of our reverse repo book. And the reverse repo book is – I hopefully got across. A lot of that has gone through segregated accounts through a central clearing, the FICC. So there’s very little capital that that business uses, very, very little capital. So it’s not a capital intensive business at all. But again, that side of our balance sheet really is client driven.

The reason we’ve been shrinking that balance sheet is because that institutional CFD business means we had to synthetically create an underlying instrument. That’s what a CFD is. We’re synthetically creating the instruments. We have to borrow stock, again our due swaps, and all that comes in our balance sheet, and all that does eat up capital. So looking at the margins of those businesses, we made a decision that it wasn’t worth it, those margins just weren’t worth it. And that’s why we decided to shrink that business. And the result is a shrinking balance sheet. But I think be client driven, and hopefully, clients will come to us. And the balance sheet will actually start to grow again. But that would be a good thing.

Ken Worthington – JP Morgan

Thank you very much.

Randy MacDonald

Okay, Ken.

Operator

Our next question will come from the line of Alex Cram [ph] with Lehman Brothers.

Alex Cram – Lehman Brothers

Thank you. I want to come back to the net interest income and the portfolio if I look at slide 18 that Ken just referred to. Now, if I remember correctly, later in the quarter, you made this whole announcement about how the quarter is going to be a little weaker than expected because of the net interest coming down because of the rate structure. Now, you beat out significantly on the interest income. And if I look at the client cash from 4Q to 1Q, it actually only came down $20 million on a – it’s a dollar basis. The yield only declined by something like 36 basis points. And that’s a lot less than the decline, actually, that you had from 3Q ’08 to 4Q ’08. So I’m just wondering, could you talk about the months during the quarter and when you made those announcements, where you surprised at the end? Was it actually a reversal and you did a lot better than you actually thought or what happened there? In our opinion, it actually came in better than we would have thought.

Randy MacDonald

Yes, Alex. So actually, let’s go back to slide eight and take a look at slide eight because I want to point out that on the client fund column, that’s where we saw the swings in spreads, which started to happen sometime in May. And probably about mid June is when we realized that we had this narrowing spread impact on those balances. If you take a look at the column under matched principal F, we did have a nice increase in the fixed income business, which some of that gets classified as interest income. But I don’t want you to be confused between a business, like the fixed income business, that is really very client driven, very dynamic. And that business performs quite well, but again, the concern we had was the streak was at $0.27 on a consensus basis. And we saw client funds that column, column H, going through this decrease in spread. And it was a – I think that $20 million is a fairly good size movement. And that’s why we put the press release out in front of the offering of the securities.

Alex Cram – Lehman Brothers

Okay. So would you say net – it came in as you expected or do you think it actually ended up doing a little better than you thought on the time cash side in particular?

Randy MacDonald

If you look at the press release and you look at the range of revenues that we had in there, in that disclosure, we came in right where we – well in that case, we were guiding, so we said, “Here’s where think the quarter’s going to commit in terms of revenues.” And I think, we’re almost right in the middle, if I’m not – if I’m not remembering that right, somebody in the room should tell me you know. But I’m pretty positive we were right in the middle, so.

Alex Cram – Lehman Brothers

Okay. Well then, just one more question on the answers and then move on to something else. But can you just discuss how you’re positioned now? I think you started giving a little bit of detail. But if you break it down into bigger buckets, I guess, agency or CBs, overnights, and then also, contrasting US and the UK. How are you positioned right now so we can get at least a little bit of an indication of how you could be impacted as rates move going forward? And how do you – and I guess as a follow-up, how do you envision yourself changing that makeover in the next couple of months or so?

Randy MacDonald

Well, we’re going to, as I mentioned in my remarks, and I’m not going to be terribly, terribly specific about our strategy for they types of investments other than, say, they’re – they will be very liquid and high credit quality. But we are now extending the duration. With the concern that we had about any ratings actions, we were very, very concerned about the franchise, and very concerned that if we suffered a downgrade, that we would have to have our balance sheet in a very, very short duration so that we can meet possible (inaudible). Now we have the ratings affirmed, we feel very comfortable, still very, very liquid, but going out in duration. And so we expect that net interest income would see – hopefully, we’ll see a positive impact as a result of those actions. But to go beyond that, it’s not something we’re planning to do.

Alex Cram – Lehman Brothers

Okay. And then just lastly, shifting to the pricing side, now, you gave a lot of color about the pricing changes year-over-year and that the execution only wasn’t particularly driven by the energy business. So two questions on this, first, well you also said that the energy business is actually pretty – it’s actually pretty small for you. And I think, if I remember correctly, a year ago, you said it was 9% of your revenue. So just wondering how that has such a big impact, in particular as towards the screen, it’s something that has been going on for, I don’t want to – I don’t want to say, two to three years now. And then lastly, related to that, can you also talk about the pricing changes sequentially because those were pretty strong sequential declines as well? Thank you. And then I’ll jump back in the queue.

Kevin Davis

Yes. Hi. This is Kevin. Clearly, energy is not our biggest product, but it’s still an important product for us. And of course, you note that NYMEX and ICE saw very, very significant increases in their volumes during this period. And so, it’s not surprising that energy trading at the percentage of our overall business most certainly did increase. Whist it’s true to say that the migration from floor to screens in Europe happened some years ago, the migration on the NYMEX law from floor to screens actually isn’t something that’s been happening over the last two or three years. It has dramatically accelerated during this period.

I should also add that the other – another issue opposite the margins or the rate to loss was the increased percentage of our business that is represented by professional traders. Now we, as you know, took a deliberate strategic decision some while back to increase our exposure to that segment of the market because it is widely regarded as the fastest growing component of the futures industry. So the energy impact is the vast majority of that change. But from an execution perspective, and you should remember that on a market – when we trade on our market floor, there’s anywhere from five to eight people in the chain of an order. And when you trade electronically, there’s only one. And if the client does it himself, there’s none. So loss the cost associated with that or what the commissions that’s what could electronically most certainly do for. The actual cost associated with those transactions fall much more quickly.

In terms of the cleared issue, again, it really is professional trader component. And you should remember in last year’s first quarter, we didn’t have BrokerOne. Of course now, we do. So that would explain this. But in terms of the other part of your question is have we seen pricing compression. Are we being asked by customers to cut commission rates? The answer is no more than usual. And it’s not something which keeps me awake at night in any regard. And finally, I should remind you that last quarter, third numbers went up.

Operator

Our next question will come from the line of Don Fandetti with Citigroup.

Don Fandetti – Citigroup

Kevin or Randy, am I calculating this right that your repo matched book business is essentially about a quarter of your net income this quarter?

Randy MacDonald

It’s a good question. It’s a quarter –

Don Fandetti – Citigroup

Maybe give or take 20%, 25%, not knowing what the margin is?

Randy MacDonald

Yes. I’ll have to get back to that. I hadn’t thought about it that way, Don. So I apologize I don’t know the answer off the top of my head.

Kevin Davis

Our collective matched principal businesses, as we said, has increased as –

Randy MacDonald

Of the total matched business, but – yes. I mean –

Don Fandetti – Citigroup

I was talking about the repo matched book. I guess my broader question is more of – one of the reasons I suspect you’re probably making more money on that is because the banks aren’t willing to do it as much. And I just wonder if it makes sense strategically for you folks to be doing that business at this point given that you’re probably not getting as much credit on the multiple. And I guess what are the risks that – if things get better that that earnings and return go down on that business?

Kevin Davis

Let me answer that. One of the reasons why people like doing that business with us, I would say the principal reason is because we’re totally unconflicted and we don’t hold any inventory. One of the reasons why banks typically are not akin to that business right now is because they do hold inventory. And when they’re forced to make prices on certain products, they end up having to – have a remarkable impact on their own marks. But actually, I’m sitting here with our Chief Investment Officer, Don Galante, who’s very much involved with that business. Don, perhaps you’d like to add to that?

Don Galante

Yes. Just one thing to add about that, Don, I mean as we all know, a number of institutions have actually left the business over the last 6 to 12 months. And that once again has helped us to put – we’re a new part just in the last 12 months. And a number of clients have – we brought on a number of new clients as a result of other entities we have in the business. So it’s been very optimistic for us.

Don Fandetti – Citigroup

Okay. What do you think, Randy, the margin is on that business? Obviously it’s a small amount of capital, but as required, what type of margin are you running on that, a pure repo matched book?

Randy MacDonald

We haven’t disclosed that, Don. But I think your instincts are that given it’s low capital, it’s more like a transaction business, so.

Kevin Davis

The counterparty risks associated with that are minimal because it clears very, very significantly through the FICC.

Don Fandetti – Citigroup

Okay. Great. And then, Kevin, you were broadly speaking that some investors are just concerned that exchange credit futures could maybe be flat or negative in ’09. What is your thought on that? And then lastly, if you could comment on the outlook for interest rate exchange for the futures growth?

Kevin Davis

Well, it’s going to be impossible for me to predict accurately what will happen to exchange volume this year. Clearly, we’ve had some incredible years of growth. But the secular trends driving the industry remains sound. And center clearing counterparties are becoming increasingly important. And I believe that that secular underlying trend will continue. Of course, there are now a new product coming online, the ignitions related product. And of course, as Randy alluded to before, the increase in convergence between cash and futures, all of these things will represent opportunity for us.

Don Fandetti – Citigroup

Okay. All right. Thank you.

Operator

Our next question will come from the line of Rob Rutschow with Deutsche Bank.

Rob Rutschow – Deutsche Bank

Hey, good morning. I was hoping that you could give us some more detail on the actual mix of business by geography. Did you see any shift in your activity level of the way from some of the emerging markets?

Kevin Davis

Rob, the 12% Asia Pacific is pretty consistent with the tri-quarter. The only area in Asia Pacific where I could give you a little bit of color was in India. Clearly, you’ve seen dramatic declines in the equity markets over there. And we typically charge commissions as a percentage of the underlying contract there so that we have something of a depressive factor to that region’s growth. But no, the business remains pretty well balanced in much the same way as it was in tri-quarters.

Rob Rutschow – Deutsche Bank

Okay. I guess, the BIS data would suggest that activity has slowed a little bit. Would that mean that you’re taking more shares there?

Kevin Davis

Well, I think some of the initiatives, strictly in India, will result in a high market share. We are the first company that want – that was (inaudible) to the license to provide direct market access in India. And we’ve also got some other DMA projects going in the region. So I do think our market share, in general terms, will increase. And we are still looking and examining opportunities, as I said in my speaking notes, in Taiwan, Japan, and Korea, and ultimately, across Mainland China. So it’s quite a lot to be excited about in that region.

Rob Rutschow – Deutsche Bank

Okay. And the second question’s for Randy. I know you can’t give us guidance on the actual cost of the new funding, but I’m hoping maybe you could guide us in terms of the accounting treatment for interest expense and any possible dilution.

Randy MacDonald

Why don’t we do that on the Web site for everyone. We do actually have out there some pro formas that I thought were pretty instructive. So maybe if I refer you to those, and then we can come back to you with – if you look at those and still have questions. But I think they’re fairly instructive. So everyone on the call, let’s look at the Web site. I think they’re pretty useful on that answer.

Rob Rutschow – Deutsche Bank

Okay. Thank you.

Operator

Our next question will come from the line of Rich Repetto with Sandler O’Neill.

Rich Repetto – Sandler O’Neill

Yes. Good morning, guys.

Randy MacDonald

Hi, Rich.

Rich Repetto – Sandler O’Neill

So I’m trying to see, this – the brokerage loss – the broker loss that’s in the reconciliation, is that different than the $5.5 million termination liability?

Kevin Davis

Yes. A $5.5 million termination liability relates to severance.

Rich Repetto – Sandler O’Neill

Okay. So the $0.29 that you reported non-GAAP because in the text or in the release it talks about ongoing – you really wouldn’t have that $5.5 million yield on an ongoing basis if everything was perfectly apples-to-apples.

Randy MacDonald

That’s right.

Rich Repetto – Sandler O’Neill

Okay.

Randy MacDonald

That’s true. Yes, that’s true.

Rich Repetto – Sandler O’Neill

Okay. So then the reason why is because – somewhere in the call we talked about a run rate, if we do assume that that $0.08 adjustment for the dilution of the financing, it would really be $0.03. You got $0.03 here from this termination. So it’d really be like $0.23, $0.24.

Randy MacDonald

Yes. And there’s the tax rate. So I think what you – yes, there are two things that are going on. For non-GAAP, we really have to respect the SEC and what we can put into that adjustment schedule that we do. And then, there’s concept of what is ongoing. And those are two different things. So you are absolutely correct in pointing out that there are some things that in doing your analysis, you might want to also factor into your analysis. So I completely understand what you’re doing.

Rich Repetto – Sandler O’Neill

Yes. And I totally get the accounting of it as well. And the other question is this tax rate that you’ve got, it’s at 31% after a lower tax rate this quarter. I’m trying to understand why do you expect – I heard you say that you’re confident you can now start to extend the duration a little bit. I’m trying to see why you would guide to a 31% unless it’s growth, unless you know you have some growth here.

Randy MacDonald

Well no. It depends on where the incomes earned, and certainly, the US is the highest tax jurisdiction that we operate in. And the fixed income business is primarily a US based business. So that’s why I’m being – we’ve looked at where we think income – obviously, this is looking forward nine months from now. And so I’m thinking the effective rate is going to be closer to 31. Now, I could be completely wrong if, I said in my remarks, if the mix of business is primarily outside the United States, then it’ll be a lower rate. But I don’t want everybody to take this quarter at 27%, and think that we’re going to put up 27% every quarter. So I’m just cautioning you that the US sourced income is expensive income.

Rich Repetto – Sandler O’Neill

Okay.

Randy MacDonald

Does that make sense, Rich?

Rich Repetto – Sandler O’Neill

Yes. I’m just trying to get that this isn’t a one time tax rate. This is a legitimate tax rate. And that yes – that is a legitimate – there wasn’t any one time benefits in the tax rate?

Randy MacDonald

Yes. There was nothing one time. And again, it’s estimating based on income that we actually saw for that quarter.

Rich Repetto – Sandler O’Neill

Okay. That’s all I’ve got. Thanks.

Operator

Our next question will come from the line of Niamh Alexander with KBW.

Niamh Alexander – KBW

Thanks for taking my questions. And on the balance sheet, you talked about extended duration several times, thank you. But are you done kind of shrinking the balance sheet now? Or are you kind of back into cautiously growing the business again? Or is there some more to go on the CFD business?

Randy MacDonald

There’s a little bit to go on the CFD business, but not much. Not much to talk about. So the retail CFD business is something – Kevin, you should probably talk about –

Kevin Davis

Yes. We’re still – we have not accessed the CFD business nor is it our intent to do so. What we did do was dramatically reduce our wholesale-retail at our wholesale CFD business, which did take a significant proportion of our balance sheet in Europe. But we’re still focused on a high margin area of direct retail CFDs. It is a bit as to expect to continue to grow and to flourish along with other OTC retail businesses, which we’re developing in Europe all the time, such as spreads and vineries, and other new kinds of trading products.

Niamh Alexander – KBW

Okay. That’s helpful. Thank you. And in the US, has there been any kind of progress or movement with those products there?

Kevin Davis

No. There’s been none because I’ve seen this risk right now. It’s not possible to sell CFDs in the United States market, or spreads, or binaries. Although there are some moves that sought to look at – initiate versions of some of those products. But I wouldn’t expect anything exciting to report in that regard for sometime.

Niamh Alexander – KBW

Okay. That’s helpful. Thanks. And then just to help me understand the balance sheet shrinkage. When you said there’s a bit more to go. Maybe should we think about the same magnitude next quarter or this quarter?

Kevin Davis

No. No. Not at all. No, not, not at all.

Niamh Alexander – KBW

Okay. That’s helpful. Thank you. And then a question for Kevin, it was one of the first issues in your keys to value creation here, the people. I’m just given – what happened to the stock? And the business is currently still doing well. How are you motivating and keeping your people? Is there stock compensation? Have you had to maybe increase some of the retention packages? Are you having to replace some desks? How can you make sure you kind of – you still have folks at their desks and producing at the pace you want them?

Kevin Davis

Well I think we’ve set for many, many years, even when we were part of Man Group, that we never lost a team that we wanted to keep. And that still remains the case. And while stocks has been a part of our compensation historically, it has been a much, much, much small percentage of our overall compensation. That is typical of Wall Street. And so, we have not had somewhat negative impact that other Wall Street firms may have suffered from (inaudible) clients and share price.

In actual fact, not only did we not lose any teams, a very significance in these past five, six, seven months. We’ve actually began to add teams. We’ve added two new very exciting teams in our fixed income space. We are also adding teams in Asia Pacific and in Europe. And of course, because of the way, in which we compensate our staff, we certainly attract the sorts of people who are very, very confident in their ability to bring their customers with them. And staff retention, our track record is really quite spectacular.

Niamh Alexander – KBW

Okay. That’s helpful. And I shouldn’t think about the bringing in kind of, Tina’s a producer there, like in the IDB where I was worried it would be kind of initial upfront guaranties of size?

Kevin Davis

There are some upfronts in that regard. But unlike the IDB business, we don’t end up getting burdened perpetually with having to go rehire the same teams every two or three years because typically, when our progress teams move. Moving their customers with them is not quite as easy as is the case in the IDB world.

Niamh Alexander – KBW

Okay. That’s helpful. Thanks. And then just real quick, can you give me a sense for July where the client balances have moved to?

Kevin Davis

We’re not going to give any guidance on that. We do understand that investors look at client funds. As we’ve said time and time again, they move up and down for a variety of different reasons. We used to say that there was sort of more of probability index than it were as a guide to our profitability, exchange of commerce move up and down, claims, (inaudible), profits and losses move up and down. A great deal depends on which way clients’ positioned ahead of significant moves in the market. So we’re not going to give any information on that. And we would really like it people would spend as much time as they did focusing on that incident.

Niamh Alexander – KBW

Okay. Thanks for taking my questions.

Operator

Your next question will come from the line of Jonathan Casteleyn with Wachovia Securities.

Jonathan Casteleyn – Wachovia Securities

I’ve got some thoughts on execution speeds. Just in the sector, the exchange is consistently plowback capital into – and just say making processing execution fees faster. Anything under the guidance of the recent compliance review or consulting review that’s kind of potentially slow down your execution speeds, can you sort of give us indication where they stand now?

Randy MacDonald

We don’t – I mean execution speed, battery from exchange to exchange, from sender to sender, and of course, different clients care about extra speeds in completely different ways. Clearly the speed of execution is most pertinent to algorithmic traders. And once we do have a very significant share to professional traders space. Algorithmic traders are not extremely significant part of our business. So as it happens, and I think that has occurred in the risk reviews and implementations that would impact speed. But frankly, speed in terms of milliseconds is not a factor determining our success or failure in this industry.

Jonathan Casteleyn – Wachovia Securities

Okay. And just trying to summarize your thoughts on potential pre-cash flow, it sounds like paying on debt and reducing the balance sheet would be first and foremost. Did that sort of take away from any offense you can play as far as growth, i.e. acquisitions, new initiatives, et cetera? And if there is room for growth, can you just summarize or rank in file what you think you can afford to grow through?

Kevin Davis

Well, I should say that the vast majority in acquisitions that we’ve done over the last 10 or 15 years have been small. Many of them have been done on an earn out basis. And they’ve really only been only two very big ones. One being GNI and one being REVCO, all the assets of REVCO, I should say. And of course, we continue to look for opportunities where they make forth. But the area of most interest to us in that regard, from a consolidation respect, remains age specific. We are looking at some small opportunistic acquisitions all the time.

Jonathan Casteleyn – Wachovia Securities

All right. Just two for Randy, real quickly. Just the mix shift in principal revenues from what you’re deeming as, I guess client driven versus the fixed income portion. Is that at the discretion of the company? Or is that customer driven, i.e. the principal revenues from financing and equities lots?

Kevin Davis

Could you say that one more time? Sorry.

Randy MacDonald

It’s client driven. It’s the answer.

Jonathan Casteleyn – Wachovia Securities

Okay. And then just on the IPO cost, it looks like the add back is not tax deductible. Is there a reason for that? When you calculate operating expenses, you basically add back most items as we say net of tax. And for IPO costs, it looks like it’s not taxed at all. Is there a reason for –?

Randy MacDonald

Actually, Henry Campbell [ph] will answer that one.

Henry Campbell

Sure. Yes. It’s under the tax rules. It could be the professional fees related to an equity offering. They’re not tax deductible for tax purposes. So therefore, you’re not going to get the benefit of it in your tax. And we add back the full amount, which is the same amount that we’re not getting the benefit for.

Jonathan Casteleyn – Wachovia Securities

So it’s consistent with the tax jurisdiction then?

Henry Campbell

Absolutely. Yes.

Jonathan Casteleyn – Wachovia Securities

Okay. Thank you very much.

Operator

Our next question will come from the line Mike Carrier with UBS.

Mike Carrier – UBS

Hey, Randy. I think on pro forma funding slide, you gave the diluted shares and then the full interest costs for dividends. So I think any color on the accounting theme, and just minimize double accounting. It would probably be helpful. And then on the tax rate, are you saying after the 27% this quarter, you’re looking at 31% for the full fiscal year. So we’ll still be in that maybe 32%, 33% range for the remaining quarters?

Randy MacDonald

Correct.

Mike Carrier – UBS

Okay. And then on the cost side if we do get into a download trending volume environment. Are there any areas on the expense base that you guys feel like you can pull down to manage some of the near term without harming the long term growth of the company? Then I have one follow up for Kevin.

Kevin Davis

Well, we’ve said in the past, to date around six to seven plots of our comp expenses are entirely variable. So if volumes do start to fall and a significant part of our – upfront of this cost will fall with them. And clearly, one of the great advantages of this industry is that electronification together with exchange consolidation will continue the opportunities for efficiency. And we are working very hard in that regard to put ourselves in the position to make sure that we can take whatever benefits accrue in that regard. You have another question.

Randy MacDonald

Well, Henry pulled out the slide that we have out on our Web site, so why don’t we try to answer that question, I’ll let Henry do that?

Henry Campbell

Sure, Randy. I think the best way to look at it is to split the calculation between the numerator and the denominator. So the numerator, obviously, base from our net income, and the denominator the weighted average shares outstanding. As you know, for diluted EPS calculations, you perform the calculation assuming all convertible instruments have been converted using the (inaudible) conversion method. So if we start with the numerator, we are currently and prospectively going to pay interest on our convertible debt that will (inaudible) interest on borrowings line on the income statement. And then we’ll also be paying dividends on our preferred series A and B shares.

Now the dividends are reflected on the income statement below the net income line when they are declared or paid. So if you start with net income in your calculations with the numerator. All you need to do is add the interest of the tax from the convertible debt to get your numerator. With regards to the denominator, you use the same weighted number of shares outstanding, which we’ve been using for our diluted EPS current option now. But you can add back all shares related to both the convertible instruments, so the convertible debt and the preferred shares, as if these are converted already. But these are – however, weighted based on when they’re actually issued. So for example, in Q1, they would just wait for a couple of days for the convertible senior notes and tier B. And in Q2, the series A will be weighted for, I guess two and a half months, I think. Hope that helps.

Mike Carrier – UBS

Yes. It’s helpful. Okay. Thanks. And then just a follow-up, I realize that the repo business is fairly (inaudible) universe is some of the banks and brokers out there and doesn’t require much capital. But given the focus on deal averaging throughout the industry, and your leverage ratio at over 30 times for whatever it’s worth and realize it’s not much because it doesn’t look at risks. But if the market wanted you to reduce your leverage, would exiting that business have much of an impact on your client franchise? And then, if your overall pro forma ROE was about 11% this quarter, and obviously it’s below trend, and this business requires very low capital, but still a decent percent of net income to arrive at a higher ROE. Is the rest of the business on a pro forma basis and single digits in terms of an ROE? And is that a good business?

Randy MacDonald

I think what you’re asking about is scale and operating leverage. And I think that’s one of the things that over the next few quarters we need to work towards disclosing to you how that business model works. Certainly, one of the things that we’re working towards is making sure that we build things, wants, and then deliver it many times, which gets you to that scale. We’re across many time zones and many products. And so that’s part of why we brought Bernie Dannon [ph]. Bernie’s looking at that right now. So I think there is great opportunity for operating leverage. We have to figure out what’s the size of the pipe. What’s the efficiency the efficiency of pipe? And then fill it. Don, why don’t you maybe take that first question.

Don Galante

Yes. Thanks, Randy. In simple terms, if you look at the two businesses, there is overlap in certain clients. But if you look at the vast majority of repo businesses, it’s probably concentrated in about 50 counterparties, all institutional, where our futures and options business globally we have –

Randy MacDonald

A hundred thousand.

Don Galante

Tens of thousands of client. So there’s a small relationship, but they really wouldn’t affect each other.

Mike Carrier – UBS

Okay. Thanks guys.

Operator

Ladies and gentlemen, we have time for one more question. And that question will come from the line of Mike Vinciquerra with BMO Capital Market.

Mike Vinciquerra – BMO Capital Market

Good morning. Thanks for extending the call here. One question for Randy on the interest rate side, just a follow-up. When you get your extension strategy completed here over the next couple of months. Can you estimate what that will do for you in terms of spread expansion given today’s rates. I mean any idea that you can share with us?

Randy MacDonald

I do know the answer, but no, we’re not going to the sharing what our guidance is to that –

Mike Vinciquerra – BMO Capital Market

And your ultimate duration is expected to be what, about 60 days you said?

Randy MacDonald

Well that’s where we were more in the 30, 60-day range. And we brought that down to effectively overnight. So we’d expect to go back out to that range. Mike, it depends on the liabilities and what you want is matched to rations. So I think what we have is fairly a dynamic way of looking at that. And the ratio – there are a number of balances where – you’ll remember this from my previous slide, there are many clients who – especially in the retail space, who earned $0. So as rates come down, our assets are re-pricing, but those liabilities are not because they were at $0. They weren’t being paid anything. As rates go up, of course, you’re re-pricing your assets again, and those liabilities are not re-pricing. So that can have a very positive impact. So as rates came down over the past year that had fairly negative impact on our pretax margins. I would expect that if rates go up that there’s good opportunity. I can’t predict rates so we don’t bake any of that into any of our thinking.

Mike Vinciquerra – BMO Capital Market

Okay. Okay. Very Good. Just one clean up question, the broker related loss of $6 million that we added back, I assume that came out of the professional fees line? Is that right?

Don Galante

Yes. That’s right.

Mike Vinciquerra – BMO Capital Market

Okay. That’s it guys. Thank you.

Kevin Davis

Okay. Well thank you very much, everybody. I look forward to speaking with you for the next few days, and of course, on our next call. Have a wonderful summer. Bye-bye.

Operator

Ladies and gentleman, thank you for your participation in the MF Global’s fiscal first quarter 2009 earnings conference call. This concludes the meeting. You may now disconnect, and have a good day.

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