SWS Group, Inc. F4Q08 (Qtr End 6/27/08) Earnings Call Transcript

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SWS Group, Inc. (NYSE:SWS) F4Q08 (Qtr End 6/27/08) Earnings Call Transcript August 28, 2008 10:00 AM ET


Jim Bowman - IR

Don Hultgren - President and CEO

Ken Hanks - CFO

John Holt - President and CEO, Southwest Securities, FSB

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

Dan Leland - EVP of Taxable Fixed Income


Chris Mancini


Good morning, everyone, and welcome to the SWS Group Quarterly Conference Call and Webcast. This is Jim Bowman of the SWS Corporate Communications 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. During the question-and-answer session, call participants can access the queue to ask questions by pressing star 1 on their telephones. Those participating via the Internet can ask questions via the provided on the webcast page or by e-mailing them to questions@swst.com.

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, and thanks for postponing your Labor Day celebration to be us this morning as we talk about fourth quarter as well as full year results for fiscal 2008.

I would like to first introduce the people we have in the room. 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; Jim Ross, the President and Chief Executive Officer of Southwest Securities and SWS Financial; and also I notice in the room, we have Dan Leland, who is the Executive Vice President of Taxable Fixed Income. So, this would be an especially good day to ask fixed income question.

Let me go over the agenda. I’ll provide an overview of the fourth quarter and of fiscal 2008, review some noteworthy items, and touch on some important events since our last conference call. Ken Hanks will provide a more detailed review of the fourth quarter. John will provide an update on the activities at the bank. And then I will finish by discussing our market position and our three primary growth initiatives, at which point, we’ll open it up for questions. And as Jim said, if you do have a question, it’s star 1 on the telephone, or if you are listening online, it’s questions@swst.com.

Let me first start with the fourth quarter overview. Net revenues in the quarter increased from $65 million last year to $88 million this year. Income from continuing operations also increased from $6.9 million to $7.3 million. The extraordinary gain that you see is the result of purchasing M.L. Stern at a favorable valuation. Earnings per share in the fourth quarter increased from $0.25 last year to $0.31 this year. And finally, we ended the quarter with the book value of $11.88 a share.

Turning to the fiscal year overview, our net revenues for the year increased as well from $274 million to $302 million. In spite of the revenue increase, net income from operations declined from $37.5 million last year to $30.9 million this year. There were major contributing factors this that were included in last year, some unusual positive events, including a fixed income transaction as well as an unusual payout of insurance proceeds to the firm.

This year’s results were negatively impacted by one-time hiring expenses in our clearing division. Earnings per share from continuing operations were a $1.13 for the year, compared to a $1.37 last year.

Now, last year we provided you with the presentation that excluded some non-recurring item. By providing this information for you again this year, you can see that the adjusted earnings per share from operations remains $1.13 this year, but it compares to $1.26 last year. I have to say that I am very proud that our team was able to deliver these kind of results in a year it was difficult for our industry.

Let me turn now to noteworthy items. The fourth quarter was the first in which the results for M.L. Stern were included in our financial statement. M.L. Stern contributed revenues of $12.2 million and pre-tax profits of $1 million. As I mentioned earlier we recorded a $1.1 million extraordinary gain as a result of purchasing M.L. Stern at a favorable valuation.

As we discussed during previous calls, the revenue stream from corporate finance can be lumpy, based on the timing of when transactions closed. The corporate finance team closed two significant transactions in this year's fourth quarter. Accordingly, their pre-tax profits were up almost 200% from last year's fourth quarter.

Another strong contributor within our institutional segment was stock loan. The spreads in this business continue to be at unusually high levels. For the quarter the spread was 69 basis points above the level it was in last year's fourth quarter. For the year the difference was an improvement of 44 basis points.

Also from our institutional segment, our fixed income is performed well, contributing to this improvement was the expansion of our presence in some attracted markets and a more normalized yield curve.

Finally, we were pleased when Keefe, Bruyette & Woods initiated coverage of SWS Group at June 9. They have already introduced to us to many institutional investors that we have not yet met.

Turning to important events. We have a number of important events that occurred since our last conference call. First, we completed a very significant upgrade of our back office software. This is important for two reasons. First, it allows us to offer more robust platform for all of our customers. And second, the successful completion of the upgrade freeze up our IT professionals to develop additional products and services for our customers in the future.

Southwest Securities FSB made the important step of opening its first branch outside of Texas. A solid team of experienced bankers were recruited to open a branch in Ruidoso, New Mexico. The bank also opened a branch and Waxahachie, Texas, which is just south of Dallas.

We are scheduled to convert M.L. Stern under the Southwest securities platform in mid December. This is a little later than we had originally expected, but nevertheless, I am very happy with the progress we are making in pulling these similarly cultured organizations together.

Finally, we have hired an investment bank that specializes in bi-side transactions to help us source acquisitions. The challenges this environment has created for many banks and investment firms leads us to conclude that additional acquisition opportunities will be available during this fiscal year.

I will revisit this later in the call, but for now let me turn it over to Ken. Ken?

Ken Hanks

Thanks Don. Today I would like to spend a few moment discussing fiscal year and quarterly summary financial results, then move on to the more detailed discussion of operating results and conclude by discussing our segment results.

First on the income statement. Net revenues for the fiscal year that is operating revenue plus interest revenue less interest expense were up by $28 million or 10%, while pre-tax earnings were down by $7.1 million or 13%. While we recorded a healthy increase in revenue, the increase in our operating expenses outpaced the revenue increase. There are few major items contributing to these results.

First of all, fourth quarter M.L. Stern results are included in our numbers. Stern recorded net revenue of $12.1 million and expenses of $11.1 million for our pre-tax profit of $1 million. We have also been investing in several of our businesses and that has led to increased operating expenses. We have added headcount in the clearing segment as our new head of clearing reorganizes the departments to grow. We have also opened new retail brokerage and banking location, as well as increased our product offerings and headcount in the fixed income division.

Lastly, the tightening of mortgage credit as well as the credit environment in general have impacted expenses at the bank leading to a larger loan loss provision and higher cost for maintaining REO property until their ultimate sale.

For the fourth quarter, net revenue was $87.8 million up $22.3 million or 34% while pre-tax income was up 4% to $11.4 million. The result of M.L. Stern mentioned earlier account for most of the change between the quarters.

Turning to a review of our individual operating revenue item. Net revenues from clearing were about flat for the quarter. In the quarter we processed 7.4 million trays up from 5.2 million in the same quarter a year ago. But down from the 8.9 million processed during the third quarter.

General securities tickets were up by 6%, while day trading customer volume was up 42% from the year ago period. Revenue per ticket in the June 2008 quarter was $0.51 versus $0.58 per ticket in the same quarter last year. This change is primarily attributed to the additional volume from day traders in the current quarter over last year. For the full year, clearing revenue was up 1.5 million. We processed 31.6 million tickets in fiscal 2008 versus 17.4 million in fiscal 2007.

Commissions were up 10.7 million or 42% in the quarter with 9.6 million of the increase coming from M.L. Stern. Both taxable and municipal fixed income commissions were up substantially offsetting the decline in commissions from our portfolio of trading units. For the full year, commission revenue was up 21 million other than the 9.6 million from Stern our retail business posted smaller increases in commission revenues while our fixed income business contributed a 13.5 million increase in commissions offsetting a 4.4 million decline in portfolio trading profits.

Portfolio trading did not match the prior year’s results primarily because the equity UIT markets has been contracting in the last few months and the primary class of portfolio trading are the unit trust complexes.

Investment banking and advisory fees were up 55% in the quarter with about half of the increase coming from M.L. Stern. Corporate finance also closed out the year with a good quarter causing two major transactions. For the full fiscal year, investment banking and advisory fees were up 12% to 37.5 million. M.L. Stern and Tower Asset Management contributed 1.4 million of this increase while the rest of our retail segment contributed an additional 2.1 million. The remaining increase came from increased fees and public finance and increased fees from money market balances.

Net gain on principal transactions, which is trading, they are derived principally from trade and fixed income security were up 3.7 million in the fourth quarter as compared to the fourth quarter last year. The primary driver of the increase was the elimination of the mark-to-market on our NYX stock. You may remember that we -- dividend at this stock up to the parent at the beginning of this year and I would say halleluiah this will not be a difference that we talk about in fiscal 2009.

Fiscal year results included decrease in net gains on principal transactions of 6.8 million. Last year’s includes a 1.2 million gain on the NYX stock, as well as, the 2.7 billion gain on a large restructuring transaction. Additionally, we carried lower inventories in fiscal 2008 resulting in reduced trading profits.

Other revenue is down 8% for the quarter primarily due to reductions in the value of our deferred comp plan investment. For the year, other revenue was up by 2.5 million. Last year we recorded insurance proceeds in other revenue at 2.3 million. Net interest revenue which is interest revenue less interest expense, up 28.8 million, was up 19% from last year’s quarter. The bank’s net interest was up 10% while net interest at the brokerage was up 28%.

The increase in brokerage in net interest was driven by our securities lending area where we thought spreads increased by 59 basis points over last year’s fourth quarter. We also invested in auction rate bonds during the quarter which provided 2.4 million in increased net interest. Reduced spreads on net interest earned on customer balances offset this increases. Net interest at the bank was up 10% due to higher average loan balances. For the year, net interest was up 10.7 million or 11%.

Again, stock loan was the primarily driver of the 19% increase on the brokerage side of the business. The stock loan increase was offset by reduced earnings on customer balances. The Fed rate cut during the year had an impact on margin balance spread and a dramatic impact on the marginal spread earned on credit in the retail and clearing business. While we have some flexibility in setting our interest rate, generally, our brokerage assets re-price more quickly then our liability.

I would like to address what seems to be one of the hot topics of the moment, auction rate security. As we mentioned in the last quarter and earlier today, we have strategically invested in certain auction rate bonds to take advantage of the above average yields available on certain of these securities in the market place over the last quarter. Our average investment over the quarter was 113 million. We have been very selective in the bonds we have purchased and have been able to liquidate the securities as needed.

Our customers own approximately 37 million in auction rate preferred security and 22 million in auction rate bonds. This was not a product we emphasized marketed or underwrote, and therefore we have had few issues with customer liquidity. Average margin balances in the customer side of the brokerage business, up 268 million, are down 7% from the previous quarter and down 3% from the same quarter last year.

Credit balances are down slightly for march but are up slightly from last year. Stock loan balances are down for both comparative periods. As discussed, this business line benefited primarily from increased spreads rather than balanced growth. The bank’s average loan balance was up 9.5% over the March quarter, and was up 37% over the prior year. The purchased mortgage program continues to see good growth as did our commercial real estate lending.

As expected, the construction loan portfolio continues to contract.

Now turning to operating expenses. Operating expenses were up $21.9 million from the prior year's quarter. M.L. Stern accounts for about half of the increase. Compensation increases other than Stern account for $7.8 million of the increase in operating expenses. Variable commissions and incentive compensation primarily in the institutional segment comprised about half of the increase in compensation while headcount increases in the banks were most of the remaining amounts. The $2.9 million increase in other expenses was the other main driver of increased expenses. These expenses related primarily to increased provisions for loan loss and REO expenses.

For the full fiscal year, operating expenses were up $35.1 million with compensation expense contributing $24 million of the total increase. M.L. Stern, branch expansion and PCG in the bank and increased headcount in the clearing segment contributed to the increase. Occupancy and equipment expense was up $3.7 million for the year driven by the PCG and bank branch expansion as well as increased maintenance costs for our back office system. Other expenses was up significantly, $6.7 million, driven by the increase in the provision for loan losses of $2.9 million as well as increased professional services, legal expenses and REO expenses.

This next slide presents operating results by segment for the fourth quarter. 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 fourth quarter, this segment earned $1.4 million, down $5.5 million from last year. Clearing fees were flat with last year but compressed interest spreads reduced allocated interest 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 impacted this segment. As other segments have become more efficient by compressing their trade, this segment has picked up more of the underlying fixed costs since these costs are primarily driven by ticket count.

The retail segment encompasses our private client group as well as our independent contractor/brokers that are housed in SWS Financial Services along with our M.L. Stern business. This segment also includes the product lines that directly support these sales forces.

As we indicated previously, M.L. Stern contributed $12.1 million in revenue and $1 million in pretax income to this segment. Excluding Stern, the retail segment posted slightly lower net revenue with pretax profits down $1.7 million. While our recruiting efforts produced some success in the quarter, the compressed interest spread and volatile market lead to reduced revenue. Operating expenses were also up from a new office opened in Southlake Texas as well as increased technology costs.

The institutional segment consists of our brokerage businesses that serve as 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 163% for the quarter as all of the business units in this segment showed improved results over last year. Both taxable and municipal units improved dramatically as volatility and a more normalized yield curve helped increased volume. We kept taxable inventories light in the quarter but continued to selectively invest in municipal auction rate bonds in the quarter due to their attractive yields. This investment led to the increase in our short-term borrowings on the balance sheet and to an increase of approximately $2.5 million in net interest revenue for the municipal business unit. Stock loan continued to post improved results due to spreads 59 basis points higher than last year. The equity side of the institutional businesses was up marginally versus last year while two transactions in the fourth quarter lead to a 194% increase in pretax from corporate finance. The banking segment produced an increase in net revenues of 9%; however, a $1.1 million addition to the provision for loan losses in the fourth quarter, higher compensation costs, and increased cost of REO properties reduced pretax income by 43%.

John Holt, the CEO, will provide additional color on the banking environment a little later in the call. The other segment includes corporate investments as well as the unallocated corporate administrative expenses. This is where we recorded the prior year's changes in value of NYX, the results of our venture capital investment as well as the administrative cost of accounting, legal, compliance and other corporate shared services.

Primary changes this year over last year include reduced income from our deferred compensation plan as well as the elimination of the mark-to-market on the NYX stock. We present fiscal year segment results on this slide. For the full year clearing posted a 4% decrease in revenue but a 42% increase in pretax income. Ticket fees were actually up 12% year-over-year, however, allocated net interest revenue was down 23% from reduced interest spread. Higher expenses from new department management as well as increased technology expenses were the primary contributors to the decline in pretax.

The retail segment revenues were up 20% over last year with most of the increase coming from M.L. Stern. Our existing retail business showed moderate operating revenue increases but reduced net interest revenues similar to clearing. Branch office expansion and technology expenses also reduced profitability. Full year results for the institutional segment flowed similar to fourth quarter results with revenue up 19% and pretax income up 51%. Pretax income from taxable and municipal fixed-income were up over 100% from last year as we were able to profit from the volatile market while keeping our inventory light.

The investment in auction rate bonds also contributed to the success. Stock loans spread were 44 basis points higher in fiscal 2008 than in fiscal 2007, leading to increased profit from this unit. Corporate finance and equity trading end of the year about even with last year. Lastly, I would like to discuss the few operating statistic for the quarter.

Tickets processed increased 42% from last year's quarter, while dropping 17% over March. Activity from day trading customers is the primary driver of these changes. PCG reps are up significantly and include the 1% reps from a M. L. Stern. Even without a M. L. Stern our rep count was up 7 as we had a good recruiting quarter. The total employee head count increased includes 215 employees of the M. L. Stern with the rest mainly in the banking segment.

Our next slide present average loan deposits from capital balances at the bank. We also highlight the amount of deposits provided to the bank by brokerage customers which averaged $852 million in the fourth quarter versus $708 million last year. Our reserve to ratio is 74 basis points, while our percentage of nonperforming loans to total loans is up to 2.51%.

Net charge-offs were $706,000 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 June 2008 quarter, the provision for loan loss allowance was $1,131,000.

Our net interest spread in the quarter was up 60 basis points from last year which show like 14 basis point recovery from the March quarter. Provided interest rates remain stable or rise, we should be able to improve the spread in the coming quarters.

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

John Holt

Thanks, Ken. I would like to update our listeners on the bank's results and our three primary lines of business. And those three primary lines of business would be commercial banking, which includes our full-service banking centers and our SBA lending area. Second would be residential construction and third would be mortgage purchase lending.

Against a backdrop of turmoil in the financial and credit market I am very pleased to announce the banking segment, pretax net income of $17.7 million for the fiscal year ending 2008. We experienced significant loan growth, up over 37% or $330 million for the year due primarily by commercial banking and mortgage purchase. However, the strong loan growth has been initially offset by margin compression due to decrease in interest rate environment and the lag in repricing our deposits.

This was a year of change, growth, and expansion of the bank. And I am encouraged by the team we have build to support the initiatives of becoming a regionally focused, broker bank. Throughout the year, we focused on building for growth whereby the bank invested in the addition of supported infrastructure in the form of management personnel, enhanced technologies, new locations, and revenue producing bankers and that also includes our addition of our new SBA team. Further we are working towards implementing a new cooperating system which will better equip our bankers with the loan, deposits, and cash management product needed to compete in the market place.

This new technology platform will enable us to scale our operations by a magnitude consistent with our growth initiatives going forward. I am convinced we have a right team in place to leverage the competitive advantage that is inherent in the broker bank model. Under commercial banking, we are committed to grow our commercial banking presence across Texas and the Southwest. And in doing so, we will focus on enhancing franchise value by building banks around experienced bankers. We have opened two new full-service banking centers, I think Don mentioned it one in Waxahachie, Texas, which is suburb of Dallas and the other in Ruidoso, New Mexico.

As our team in Waxahachie quickly grew their presence and outgrew their loan production office. We committed to opening a new location and eager to capture substantial market presence in the southern suburb of Dallas. Our new banking center in Waxahachie demonstrates that our model of building around the bankers is functional, profitable, and can be replicated going forward. Our full-service banking center in Ruidoso, New Mexico marks the first time in our history the bank has extended his banking center presence beyond the boundaries of the Dallas-Fort Worth marketplace.

Additionally, our Ruidoso office gives us the opportunity to prove that our model is affordable and sustainable while indicating the commitment to allowing the bank's geographic reach with a corporate footprint across the Southwest. Under the area of residential construction we still anticipate continued manageable deterioration in bank's residential construction portfolio. The residential construction portfolio is declined by 16.6% annually, reinforcing our prudent approach to monitoring this portfolio in the existing client base. Market metrics have shown moderate absorption as finished vacant inventory has decreased slightly from three months to 2.8 months supply during the quarter.

Approximately 70% of the bank’s non-performing assets are related to single-family residential construction and lot and land loans. While this also represents approximately 82% of the bank's real estate owned portfolio.

We actively managed our non-performing assets as we take them back, we are pleased to say we sale the properties and take advantages of the market which is better in the Dallas-Fort Worth than some of the other areas.

We are committed to this line of business, however, going forward we are focused primarily on credit quality initiatives thereby improving underwriting, decreasing loan-to-value ratios and enhancing sub-market analysis.

Mortgage purchase, mortgage purchase lending ended the fiscal year with average loans outstanding of 320 million, up 17% for the linked quarter. With a focus on controlled growth for the quarter, we have taken several measures to ensure our credit quality remains intact and our collateral is deliverable to investors.

As a result, we have reduced our existing customer base, reviewed and refined our approved investor list while also tightening our operating procedures to better track collateral while in our pipeline.

Further, we continue to operate only on a flow basis by funding individual mortgage purchases with forward sales commitments.

In all I am encouraged by the management team we have in place as we focused on building franchise value and increasing our regional presence across Texas and the Southwest. Don,

Don Hultgren

Thank you, John. And let me remind the audience if you have a question, it is Star 1 on the telephones or if you are listening online, it is questions@swst.com. I'd like to talk now about our current market position, in other words, where we are. We are the largest brokerage firm, headquartered in the Southwest. We are the largest broker bank headquartered in Southwest. And we are one of the largest clearing firms in United States based on the number of clients.

Turning to the next slide, as suppose to where we are, this is a map that shows where we want to be. In the past, I have tried to explain this verbally and my success their caused me to use the map for this presentation. This I would point out is for two lines of our business. The Southwest part of the United States is where we’d like to have our presence for the bank and where we’d like to have our presence for our private client group which is our employed brokers. With that in mind, we have a national presence in the rest of our lines of business including clearing and our institutional business as well as our independent contractors. But this is an area of opportunity where we believe the market place is underserved and where we believe as I have mentioned before, we can grow both organically and through acquisition.

Turning to our corporate direction, we have been pretty simple on this goal over the past few years. We want to grow our clearing business, we want to grow our broker dealer, and we want to grow as a bank. Let me first start with the broker dealer. We offer a very good alternative to financial professionals. Many financial professionals today find themselves in a large organization that is essentially telling them how they wanted them to do their business. In addition to that, many of those large organizations have been struggling as you have seen in financial press.

As a clear differentiator, on our platform the broker is our customer. We are here to provide the broker with necessary tools that he or she needs to do what they believe is in the best interest of their client. The broker runs their business in a way that they feel is appropriate for each individual client and we run our business in a manner which we feel is appropriate to facilitate the broker being able to do this. This is a significant alternative to such financial professionals.

Now the addition M. L. Stern is a significant step in growing the broker dealer. But we also have three in-house recruiters working to grow both PCG and SWS financial. And I’d emphasis when we talk about growing the broker dealer we are not just talking about growing the retail side of the business. As both Ken and I have stated in our presentation, we have been aggressively growing our institutional ranks of bankers, sales people, and traders. We have tremendous opportunity in this displaced market where we are able to find very talented professionals that we can bring on in our institutional area and I am pleased that the people who are managing those areas are taking advantage of these opportunities.

Let's talk about growing the bank. The environment here is also helpful to us. In the past, John struggled with the de novo banks. As we tried to recruit bankers onto our platform, they were frequently attracted to the de novo banks where they felt they could get an equity position and make a substantial amount of money when that was liquidated in the future. The way the market is today, it doesn’t look like it’s going to turn out that way. And so, being a well-capitalized organization with very professional and a commitment to growth in a difficult market, is now a very attractive alternative to the bankers in our target market. And as John mentioned, I think he has put together an extraordinary management team at the bank.

I’m very pleased with the strength, and the focus and the energy that we see at the bank and I’m very optimistic that the bank will continue to outperform the industry. And in addition to outperforming the industry, be able to take advantage of some of the disruption in the industry.

Finally, let me turn to the clearing side of the business. We’ve talked about this many times. We have substantial excess capacity. A number of years ago we put in a system designed to handle tremendous amounts of volume and it creates an opportunity for us because we own our system – it means we have a fixed cost operation. Contrast that with many firms that don’t own their system and run on a variable cost model. The difference is that with a fixed cost model we have substantial operating leverage as we bring in more revenue on that fixed cost.

We have been in the process of investing in numerous new professionals to help us grow that revenue line. We have a new management in the department. We have a completely new sales force. We have new product professionals.

I believe we have the people in place that can help us grow the revenues that can help us take advantage of the operating leverage that we have in clearing, and that can help us drop earnings to the bottom line from this division.

Finally, let me turn to acquisition opportunities. I think this is a time of great opportunities for SWS Group. If you look at what we’ve done in recent years, we have succeeded in focusing the firm onto those business areas where we have the ability to capture significant market share.

In addition to focus, we have brought in professionals with fresh ideas and energy to help us grow the bank, the broker dealer and our clearing business. At the same time, our balance sheet remains strong. We are positioned to grow at a time when many in our industry are struggling.

I believe this confluence of conditions means that fiscal 2009 is a year in which we should be able to expand through acquisitions in our core businesses. As I mentioned, we have hired an investment banking firm to help us source these potential acquisitions.

I look forward in the quarters ahead to be able to talk with you about both our internal growth and any other potential external opportunities that we can successfully identify.

In closing, these are exciting times for SWS Group. We have the strategies and the people to achieve our objectives of growth. I want to thank our employees who go above and beyond the call of duty to help us execute our new strategy. SWS Group has great employees, and I’m proud to be on your team. I also want to thank our customers. They are the reason we are here, and we strive to earn new business everyday. And finally I want to thank you, the shareholders for your confidence and support, and I look forward to sharing our progress with you in the upcoming quarters.

With that, let’s turn it over now to questions. (Operator Instructions) or you can reach us through email at questions@sws.com.

Question-and-Answer Session

Don Hultgren

It looks like we may have one out there; we are just trying to figure out how to get them up on bridge. Either that or Labor Day is coming early for us here.


Sir, we do have a question over the phone, would you like to take that?

Don Hultgren

Yes. Please.


Okay. The question comes from Chris Mancini, your line is open.

Chris Mancini

Hi. When I am looking at your bank -- your performance in the bank, and you said that your 70% of you NPAs were in single family. So of that $99 million of loans in single family, I guess, it seems like a large portion of that number of loans were NPAs. Is that the right way to look at it or is there a -- am I looking at it the wrong way?

Ken Hanks

Chris, this is Ken, and I will give you a quick little first part of it and then I think John will follow up. When he is talking about the single family that is in the REO, he is actually talking about construction loans that have completed the house and the house is now ready for sale but for whatever reason the builder has not been able to sell it and we have eventually have had to take it back. So it is really out of the loans to builders and developers, the majority that is. John?

John Holt

That would be correct both on the nonperforming asset side, as I mentioned, that would be approximately 70%. And then actually of the real estate owned that we've taken back from the builder, that is the percentage there. I think approximately $34 million would be the in NPAs plus the real estate owned.

Chris Mancini

Okay, so when you break it down on the slide number 20 that loans to builders and developers and there is construction of $196 million outstanding, so that is where the -- that is where the large portion of the NPAs for the quarter would have taken place?

John Holt

That would be correct.

Chris Mancini

Or reside? Okay. And then can you talk about -- are those mostly in the Dallas area? Do you have a geographic breakdown?

Don Hultgren

Yes, it's going to be primarily in the North Texas or Dallas-Fort Worth market place. We have just started having a few loans on the residential construction side in Ruidoso, New Mexico so it is really primarily North Texas.

Chris Mancini

And how have delinquencies been trending?

John Holt

They have been leveling off so I don't think we are seeing a dramatic increase but I think we will still have several quarters, you know, delinquencies as a probably been in the past few quarters.

Chris Mancini

Okay. And you said you are scaling back somewhat there in terms of that asset class? Or are you just being more -- is it because you are being more credit restrictive and that's leading to the decrease in loans in that area or how is that working?

John Halt

I can answer that. It is really twofold. One is we are scaling back or dialing back in that area. If you look at last year June 30,2007, we are $235 million this year, 196, so we are looking at really both dialing back as well as improving the credit initiatives, lowering the loan to value ratios. On the homes, less specs, more contracts and so it's really a model change on the approach to the business.

Chris Mancini

Okay. Great. Thanks a lot.

Ken Hanks

Can I add one thing to what you said, John? The total NPAs which includes REO is the $34 million, it's not $34 million plus REO. That includes the REO.

Chris Mancini

So, its $34 million in NPAs as of June 30 and that is 70% of those are within that construction and lot of land sector, is that right?

Ken Hanks

That is correct.

Chris Mancini

Okay. Thanks a lot.

Don Hultgren

Okay. Right now we don't have anybody in the queue. So if you do have questions, hit Star one and we will get you in there. Okay. We are not seeing any additional questions. Again I want to thank you all very much for joining us to discuss our fourth quarter and year. I hope we are able to show you that we are very excited about the opportunities that are ahead for us this year. And as I said, I look forward to talking to you in subsequent quarters about those opportunities. So, thanks for joining us and have the great holiday.

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