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February 8, 2008 Friday

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HEADLINE: Bear Stearns at Credit Suisse Group Financial Services Forum - Final

BODY:
SUSAN ROTH KATZKE, ANALYST, CREDIT SUISSE: Welcome back for our third and final day of this
conference. My last speaker, certainly not least in any way, is Sam Molinaro, CFO and COO of Bear Stearns.
Clearly, 2007 was a challenging year for the Bear. The stock is still well off its lows, still even further off of its
highs and, in our view, still discounting very little in the way of recovery. There's clearly risk remaining, but there's
also, very clearly, a pretty strong franchise here.
So with that, let's have Sam walk us through where the Bear is today.
SAM MOLINARO, CFO AND COO, BEAR STEARNS: Thank you. Good morning, everybody. Let's talk a little
bit about where we've been and where we are and kind of where we're going.
Obviously, 2007 was certainly a year we'd all like to forget, a year we'd like to forget at Bear Stearns and turn the
page and move on. But just to give-- share with you a little bit of information about where we see ourselves today,
clearly, having gone through a challenging time last year we come out of that. We think the franchise is still very much
intact and we think it's been much overblown, the damage, if you will, to the overall franchise. We think the franchise is
still in very strong shape, because, at the end of the day, the franchise is really about the people and the people are intact
and we think the balance sheet is strong and we're in reasonably good shape as we head into 2008.
So what have we been focusing on? What we've been focusing on has been getting risk down, getting the balance
sheet down, maintaining a very strong liquidity position so that we can weather the storm, getting expenses down --
we'll talk a little bit about that -- and continuing to invest in the core business areas that we've been investing in over the
years with a goal of growing the franchise and diversifying the revenue stream.
If we look at 2007, it wasn't all bad. Clearly it was very bad in the mortgage market, very bad in certain sectors of
the structured credit markets and in the leveraged finance market, but it certainly was not all bad.
Our international business in 2007 had a record year. International revenues were almost 30% of firm-wide
revenues. Now I will admit that while there was revenue growth internationally, U.S. revenues took a pretty big hit, so
that's the reason that the percentage is so high. But nonetheless, our international revenues continue to perform well and
the business continues to perform well.
In the equity businesses, we had record years across much of the equity franchise. Institutional equity, global
clearing services, private client services all up, all having record years. Our international equities business having a
record year, equity derivatives -- really, across multiple business lines in the equity franchise, all enjoying very strong
performance.
Of course, that performance was largely masked by the difficulties that we and a number of others had in the fixed
income area. Obviously, the large losses that we took in writing down our CDO subprime and mortgage inventories,
difficulties in the credit trading markets, which were quite dislocated in the-- late in the year, certainly in the fourth
quarter, had the effect of offsetting a lot of that strong performance.
So our performance last year and certainly our performance in the fourth quarter was extremely disappointing to all
of us. It's the first time in the Company's history we had had a loss. It's not something that we'd like to get used to
having and we're doing everything we can to turn that situation around.
One of the things that we focused on pretty intently during the end of last year and into the beginning of this year
has been getting the Company's cost base right-sized for the operating environment we're in. So, obviously, when you
look at the business, there are a number of areas that need to be addressed.
One of the most glaring is in the mortgage area. Over the last several years, as you all know, Wall Street has
evolved to an aggregation and distribution model in the mortgage space of aggregating mortgage whole loans, non-
agency mortgage whole loans, for distribution.
To that end, we had executed a vertical integration strategy designed to build up our origination capabilities, both in
the prime and near-prime markets, as well as in the subprime market. During the fourth quarter, significant cost
reductions were executed there. We took our head count down by about 800 people in that operation, eliminating about
two-thirds of the total head count, consolidating subprime and near-prime activities and significantly down-sizing the
cost in order to get that operation at a level that we think makes more sense in this operating environment.
In addition, there were head count reductions across a number of other business units that have been adversely
impacted by the market environment and, as a result of that, we took about 1,400 employees out of the organization,
almost 10% of our head count, and took out about $250 million in compensation costs and, obviously, there'll be
additional costs that will come out as a result of that significant head count reduction.
So we think the business, from an operating cost perspective, is reasonably well right-sized as we move into 2008.
Now when we look at the revenue-generating capacity of the business, the operating earnings capacity of the business,
certainly in an environment like this, I think the negatives tend to be dwelled on very significantly and for good reason,
because the losses last year were very significant.
However, when you look at the long-term track record of the Company, we've had a very long record of being able
to drive revenue growth and increase profitability and I can assure you that didn't all come from the mortgage business.
When you look at 2007, clearly revenues were not even $6 billion and were significantly adversely impacted by the
write-downs that we took in our mortgage business and in our leveraged finance business in the third quarter.
But just to get a sense of what the overall level of revenues were in the organization, excluding those, you can see
that just adding back the disclosed losses that we took in the third and fourth quarter you get to a number of about $8.7
billion. Now I'm not-- I'm not suggesting for a minute that that is a revenue level that you should all be focusing on as
we go forward into 2008. I'm not going to try to predict that, but I do think it's indicative of the overall revenue-
generating capacity of the franchise, even with very little contribution from the mortgage business.
Again, when we look at-- just to emphasize that point, when you look at 2007, obviously this was a tale of two
halves in 2007. The first half of the year -- and actually kind of interesting, because as I got here last night I was
thinking about the operating environment that we were in a year ago, because the Wall Street Journal today had a story
about the operating environment we were all in a year ago. Certainly a heck of a lot different than where we find
ourselves right now.
But when you look at the first half of last year, almost $5 billion of revenues off the franchise, making $1 billion,
$7 in earnings and then, obviously, the second half, which was a complete disaster on many fronts, with the losses that
we suffered in the mortgage area really just overwhelming the rest of the franchise.
But when you really look at the second half of last year, there were really, from our perspective, a couple of key
decisions that were made during the year that really colored the rest of the year and I think that when you look at 2007, I
don't know that there's ever been a year as defined by one or two decisions that were made from firm to firm, across the
Street, and what the impact of those decisions were on those companies' operating performance.
 Certainly one of the decisions that we made and one of the things that when we look back on '07 we are particularly
not pleased about, we were clearly far too slow to recognize the impact of the growing subprime problem and the
impact it was having on the capital markets, heading into the second half of the year. And, as a result of that, in the
spring of '07, following the first shudders in the subprime market, a couple of key strategic errors that we made was
believing that the environment was contained, ramping back up again in the CDO business, particularly the CDO
warehousing activity on behalf of clients, and not being conservative enough and not being bearish enough on the
subprime market and not being short enough. And, as a result of that, we had significant losses, all of which has been
disclosed and discussed.
But it really completely colored the second half of the year and really colored the Company's year for 2007 and
those are decisions that, as we look at them, those weren't things that we couldn't do anything about, those were
conscious decisions that were made. Unfortunately, you're not always right in this business and this was a year where
when you weren't right, it really hurt, because it was very difficult to rectify that decision once you were in there.
So, again, just to spend a few minutes looking at some of the business activities, to give you a flavor for this, when
you really peel beneath the surface and you get into some of these areas, you look at our international revenues, you'd
see international revenues over the last three years up sharply. Revenues last year were a record, about $1.5 billion from
international activities.
The global equities business continuing to grow, both cash equities, derivatives and prime brokerage and clearing.
Investment banking on a nice trajectory last year. Second half of the year certainly took a little bit of the-- took a little
bit of the momentum away from that business as the markets dislocated and much of the activity that had been in the
backlog and in the pipeline was not able to be materialized.
Wealth management -- a tough year in wealth management, obviously, and BSAM will talk about that in a few
minutes, but if we-- if we try to, again, isolate the effect of the problems that we had with our hedge funds and look at
what the run rates of revenues were, wealth management actually had a very strong year with revenues of approximately
$1 billion.
And then lastly, fixed income and fixed income, as we've said, very tough environment, very difficult year.
Revenues plunged as a result of the write-downs, but, again, if you try to normalize for that and try to understand what
the rest of the business looks like, you can see that revenue levels in fixed income, even with a-- what is essentially a
very minor contribution from the mortgage business, still running at about $3 billion across the rest of the franchise.
So with this operating environment in mind, you have to do the things that are in your control. There's not much
that we can do about the environment that we're operating in, but the things that we can work on is trying to make sure
that we got the balance sheet as strong as we possibly can.
We've been focused over the last six months on getting the balance sheet down, shedding assets, eliminating trades
that don't make sense, obviously, in the current cost environment, and trying to shed high-risk assets. As a result, the
balance sheet was down to under $400 billion at the end of the fourth quarter from the level that we were are in the
second quarter of '07.
Importantly, our capital position, we think, is very strong, both the equity and total capital. We think our capital
ratios are in good shape and our capital position is strong.
Balance sheet liquidity has continued to improve throughout the course of the year. We spent an awful lot of time
trying to reduce our higher-risk asset categories, whether those are subprime mortgages, CDOs, or leveraged finance
and we'll talk a little bit about that.
And then retained interest, which is always something that seems to get a certain amount of attention, which kind of
ballooned up a little bit during the year, largely as a result of the decision to securitize everything that was in the--
essentially in process in the securitization business during the late third and early fourth quarters, securitize the whole
loan inventories in order to put them in the securities format, distributed what we can, made it easier to finance, but, as a
result, our retained interest increased quite a bit from the levels we were at in the second quarter. But by the fourth
quarter, we were starting to bring them down and, most importantly, the non-investment-grade portion of retained
interest actually declined.
We talk about the capital base, we didn't see a tremendous amount of growth in equity capital in '07. In fact, equity
capital actually declined a bit in '07. While there was some earnings, the reason it declined is we had share buy-backs
during the year that had the effect of pushing equity capital down slightly.
But as we come into '08, equity capital still at approximately $12 billion. We have a pending transaction with
CITIC Securities, which we announced during the fourth quarter, which I'll talk about in a little bit from what the
impact of that is on an operating basis. But the CITIC Securities investment and transaction will raise $1 billion in a
convertible trust-preferred security. So when we aggregate that, look at that on a pro forma basis, together with almost
$65 billion of long-term debt, we think that our total capital position is in very strong shape as we come into '08.
Looking at the funding side, clearly an area of focus throughout the year. Fortunately for us, this is an area that we
had been really on top of, coming into 2007. We had a goal coming into 2007 of shifting our balance sheet from a-- its
short-term funding orientation from what had been driven off of commercial paper and unsecured financing,
backstopped with a liquidity plan to take your liquid collateral and pledge it in the event of a market disruption. That
had been the old plan and coming into '07 we had shifted that plan to move towards a strategy of putting collateral out
in secured repo form, generally on a term basis, financing much more of the balance sheet on a fully secured basis and
establishing a parent-company-only liquidity pool so that we would be in better shape to weather a storm, if and when it
hit.
And I say that that was fortunate because certainly in the third quarter, I think had we not done that, it would have
been a very difficult environment to have to take what had been, if we look back to November of '06, when we had only
$5 billion of secured financing and $24 billion of unsecured financing, in a crisis like we saw in the third quarter and
into the fourth quarter, to have to take that much financing and go to the secured markets and try to-- try to arrange
secured financing, I think, would have been very challenging.
So, in any event, as you look at what transpired over the course of the year, you can see that our funding mix
shifted dramatically from being almost all driven by unsecured commercial paper and short-term borrowings to being
fully secured. So the secured funding going from $5 billion to $32 billion, almost $33 billion and unsecured funding
going from $24 billion to $10 billion and, importantly, commercial paper borrowings going from about $20 billion to
about $3 billion. So a very dramatic shift in the sources of financing.
Together with that shift, was a strategic decision to materially increase the Company's liquidity profile by building
a parent-company-only liquidity pool and that is just-- essentially, it's a pool of cash and that pool of cash is kept to
protect the Company from a variety of potential contingent-- either contingent draw-downs on liquidity or a potential
need for additional margin on secured repo financing.
So we came into the year with about $3 billion in the parent company liquidity pool and, again, relying heavily on
the borrowing value of our unencumbered collateral, to putting that collateral out and raising the cash balances and by
the end of the year, as you can see from these lines, a significant change in that picture and the parent-company-only
cash pool growing to almost $17 billion by the end of the year at the same time that our commercial paper balances
were declining significantly.
Let's take a few minutes just to talk about some of the risk reduction measures that we've been trying to achieve.
Clearly, very focused on trying to reduce our CDO and subprime exposures. We came into the fourth quarter with about
$2 billion in ABS CDO exposure, some of that in inventory positions. Some of those positions had been acquired in the
unraveling of the High-Grade hedge funds and the repo facility that we provided to one of the funds and the subsequent
seizing of that collateral, as well as our CDO warehouse activities, which was one of those things I alluded to as what I
would say was a pretty important strategic error that we made in '07.
So, at any rate, we had about $2 billion of ABS CDO activity coming into the fourth quarter. By the end of the
fourth quarter, that was down to $755 million. Importantly, the CDO warehouse exposures had been completely
eliminated. We had liquidated that underlying collateral. We had taken our losses and moved on and much of the ABS
CDO exposure was similarly reduced.
When you look at the subprime positions, we came into the beginning of the fourth quarter long about $1 billion.
By the end of the quarter we were short almost $600 million and that position, since then, has continued to move in that
direction. We're now actually short in excess of $1 billion. So we have significantly reduced exposures in one of the
most problematic areas that we've been dealing with.
Another area that certainly gets a great deal of interest are level three assets. I thought I'd spend just a few minutes
talking about level three assets. I realize that the perception is that level three assets are a bad-- a bad word and have a
bad connotation, somehow implying that we're able to make a decision to put things in level three and not deal with
them and not mark them to market and that couldn't really any farther from the truth.
What level three really tells you is the level of observability of prices in many of these markets. And the reason that
level three assets rose from $20 billion at the end of August to $28 billion at the end of November really has more to do
about-- to do with the state of the markets and the lack of observability on prices in many of these assets.
Historically, a variety of products have been in level three. Some of our distressed securities trading, leveraged loan
trading, has historically been level three assets. But certainly the big change during the course of the year has been the
lack of observability in the mortgage markets, both in certain sectors of the residential market with CDO markets, and in
the commercial sector.
When we look at the change quarter-over-quarter and why did it go up so much, which I know has been-- there's
been some questioning about that, the main reason for the increase was execution of-- we were involved in the financing
of Blackstone's acquisition of Hilton. That deal was not-- was in our commitments at the end of the third quarter. That
was funded late towards the end of the fourth quarter. Our involvement in that was about $5 billion, so that impact is in
these results and it's the reason that the commercial exposure or the commercial level increased so much.
So really pretty straightforward. There's really not much else going on here, other than that.
If you look at our leveraged finance pipeline, certainly coming into the second half of the year the leveraged
finance pipeline was at a very high level, $20.8 billion of commitments at that time. By the end of the third quarter, that
was down to $7.6 billion and by the end of the fourth quarter, that was down to virtually nothing and today we have
nothing in the leveraged finance pipeline. So we're completely out of that.
Most of that risk has been distributed, has either been distributed or is the result of deals breaking. If you look at the
third quarter level, that $7.6 billion number, a large part of that was our exposure in the Cablevision deal, which, as you
know, didn't happen. So a big chunk of it went away. That that didn't was closed and either-- was distributed or if it
wasn't distributed as an inventory, has been marked down.
Commercial mortgage activity -- obviously another important area of focus. A great deal of speculation today over
whether the commercial mortgage market is going to be the next shoe to fall, if you will, in the global credit crisis.
Our commercial mortgage inventories at the end of the year are about $15 billion. About $3 billion of that is in
fixed-rate securities, $12 billion in floating rate. Again, a large portion of the total exposure here is the Hilton
transaction, which is about $5 billion that's been, I think, pretty well covered by both rating agencies and the media as to
what the status of that deal is.
When you look at the breakdown of the activity, we look at it by property type, obviously, a large portion of the
total commercial mortgage exposure is in the hospitality industry. The other large exposure is in the office building area
-- very little exposure in retail and other areas.
If we look at the distribution of where the properties are, clearly heavily influenced by U.S., but reasonably--
reasonably split with Asia and Europe and the portfolio has, essentially, we think, very strong credit quality, certainly a
major difference between the commercial market and the mortgage market is fundamentally the underlying credits are
in much better shape. We have not seen high levels of defaults. We haven't really seen any defaults and the underlying
cash flows continue to be strong. This is a portfolio with a weighted average loan-to-value of about 70%.
One of the areas that we really had to challenge ourselves on coming out of this past year was to look at our risk
management structure. I think, for those of you that have followed the Company for any period of time, I think that we
have long prided ourselves and taken a great deal of pride in our risk management culture. And I think that when we
look back on '07, I think if we were going to be critical of ourselves, we'd have to acknowledge that we probably relied
too much on our culture and not enough on our process in managing the risks of the firm.
So while we want to maintain our risk culture and we want to maintain a culture of what we think have historically
been very careful risk takers and not people that like to play in a big way in the proprietary trading areas and taking
directional exposure, we certainly needed to make some changes in our risk management processes and we have.
During the course of the last three months, we've formed a risk policy committee. Our global head of risk chairs
that. He reports directly to me now. Alan Schwartz, our new CEO, is actively engaged in that committee. All the
committee-- all the senior heads of the business units are part of that committee and we're reviewing risk firm-wide on a
weekly basis in a very engaged way. So we think that we've made significant improvements in our risk management
processes, which, we think, will both enable us to retain our culture, but also to have a much more active dialogue
around the firm-wide risks that we're taking.
So let's focus a little bit on what the business plans are as we think about '08. What are we trying to do? We've got a
number of important strategic objectives, all of which are focused around continuing to grow the franchise and
continuing to diversify the revenue base.
We're very focused on geographic diversification -- expanding in Europe, expanding in Asia, building out our
business in Latin America. So very, very focused on developing our international activities, continuing the string of
success that we've had there, and continuing to invest behind it.
Our goal, obviously, is to expand our client base. We need to have greater global reach and we're trying to expand
our reach with our global client base.
Examples of that in 2007 in Europe -- significant expansion of our sales force in Europe, trying to touch more
clients in more geographies throughout Europe. That was the direct-- the direction behind opening up offices in
Frankfurt and Paris last year, having more sales people on the ground and expanding our reach with those clients.
Also, with existing clients, focusing on increasing our wallet share with key client relationships. That's particularly
a big focus of ours in the hedge fund space and particularly around our prime brokerage business, as well as in private
equity and financial sponsors, a number of other areas.
Diversifying product capabilities -- key examples of that would be the energy business. Asset management is an
area that we're very focused on and together with-- and part of that focus on some of these businesses is we're very
focused on expanding businesses that have higher return on equity businesses.
We need to-- when we look at our franchise, one thing that we recognize that we need to do is to expand our
business in areas that do not require significant equity. As a capital-markets-oriented firm, obviously you need
significant equity to run it, but we need to grow in areas like asset management and some others in order to enhance the
firm's overall return on equity and capital.
So just to run through a few of the opportunities across the divisions. As I alluded to, when we look at the global
equities business, a very, very strong year last year, a number of very good stories here, record revenues across the
business.
The merger that we did at the beginning of 2007 of our cash derivatives and prime brokerage platforms, which we
talked a lot about last year and I'm not sure that when you think about, okay, so they're merging their-- so what's that
going to do for them. The reality is, we think that that had a tremendous effect, because instead of running these
businesses as, essentially, three separate businesses, we were able to merge them. Obviously, they have a tremendous
amount of crossover in their natural client coverage and as a result of merging them we're able to be much more
efficient in the way we serve our clients, be able to be much more efficient in our cost structure and operating approach
and, as a result, we think we made significant inroads with clients in winning additional business and generating these
record results and we think there's a lot more to come.
When you look at what's going on in the business, in addition to very strong performance in our cash equities
business domestically, exceptionally good performance internationally, record level of revenues. As I said, the prime
brokerage business and clearing business had a record year.
Clearly, that record year did hit a little bit of a bump in the road late in the third quarter and into the beginning of
the fourth quarter. Certainly we've talked about that. We did see balances decline in the third quarter, largely as a result
of the dislocation that was going on in the markets.
We had-- did see some balance flight during that period of time and a combination of that, together with a difficult
operating environment, margin balances have declined from the record levels that they were at in the third quarter.
However, we believe that situation has stabilized. It's stabilized for a number of reasons, but I think one of which is that
our clients have gotten greater visibility and transparency into our balance sheet and what our financial situation is and
also, I think, have been greatly comforted by the structure that we utilize in the clearing business around Bear Stearns
Securities Corp., which is designed to protect their assets in the event of a problem at the holding company or above. So
I think that situation has stabilized a great deal.
When you think about the equity business at Bear Stearns, it doesn't often get a lot of attention, because our
perception is that we're such a large fixed-income shop, but, really, we're very proud of our equity division. One way to
measure the strength and the success of a division, sometimes, is to look at third-party endorsements. Take these. We're
always happy to get them, but, obviously, you have to work hard to get there, but when you look across the franchise in
equity research, sales, prime brokerage, trading, algorithmic trading -- a lot of high marks.
Research department highly regarded, number two II, number one in Alpha's-- Alpha's study, which is a hedge-
fund-oriented study. So a strong research department. Our equity franchise in the U.S. and Europe is really built around
that.
Strong rankings in sales. Very strong rankings, one, two or three, in all the prime brokerage categories. Trading
capabilities, execution -- again, all very strong ratings, which I think are indicative of the strength of this franchise.
One area that we are particularly excited about as we come into '08 is our energy business. We spent much of '07
building this franchise, hiring people, building out the organization. As you may recall, we had formed this business
really going back to '06 in a joint venture that we had announced with Calpine in early '06. That joint venture ultimately
broke up with Calpine's difficulties, but as a result of that, we had a core of people and we've built on it significantly.
We have about 200 people now down in our energy trading operation in Houston. During '07 we completed what
we think is a watershed event with our acquisition of the Williams Power portfolio, which was a portfolio of six power
plants and associated power contracts, 7,500 megawatts of gas-fired generation capacity.
We think that the combination of our sales and trading organization that we've built, together with the significant
enhancement in our footprint that gets created by the Williams transaction, provides a very strong base to build upon.
We think that this will be very important for us in '08, both from the standpoint of increasing our presence in the market
and sales and trading and structuring opportunities, as well as the-- as well as the value that we think is embedded in the
portfolio of assets that we acquired from Williams.
In fixed income, clearly it's going to be a very difficult year. There's no question about that. And in the mortgage
space we're certainly in an environment where the aggregation/distribution model has come to, effectively, a halt. Very
little new origination, very difficult to securitize. It's going to be a year of, essentially, dealing with distressed assets.
But having said that, again when we pull out the losses that we took in the fourth quarter, third and fourth quarters,
in the mortgage business, just to get a sense of where the rest of the franchise is, you can see that even-- without those,
revenues there are probably in the $3 billion range, $3.25 billion, pulling back those numbers from the $700 million
level of revenues that we achieved that were net of $2.6 billion worth of write-downs. So while there was a significant
ramp-up in activity over this timeframe from '02 to '06, I will tell you that a great deal of that came from areas other
than mortgages, particularly the rates and credits businesses.
As this slide will give you some indication, when we look at the split of the businesses, the rates, credit businesses
are substantial portions. We're very focused on continuing to build those areas out.
The credit areas, structured credit trading continues to benefit from significant growth globally in that activity. It's
certainly a tough environment with much wider credit spreads, but the volume of activity is still significant. Customer
activity is strong.
Distressed debt, the purchase and sale of distressed securities, is definitely going to be in an environment where
there is more opportunity to invest money, both for ourselves and on-- for clients in '08 and beyond.
Leveraged finance, while a difficult 2007 and we're still feeling the effects of working through the pipeline, the
significant pipeline, of deals that were out there, we think the leveraged finance market will stabilize in '08 and we'll
continue-- we'll get back on track. Certainly we won't see the large mega-deals, but we do expect to see activity build
back up again in the second half of the year.
Our rates business, very important and our global rates business has grown dramatically, both the rate business, as
well our foreign exchange business, both in the U.S. and Europe. International continues to be a key focus and, of
course, mortgage. The mortgage area is an interesting one, because at the moment what we see is a tremendous amount
of capital having amassed on the sidelines looking to be deployed.
However, with all that capital looking to be deployed, there's very-- still very little activity taking place. That's the
bad news. I think the good news is, as there's greater and greater visibility around where the housing market is heading,
where the mortgage market is going, our expectation is, activity will resume and there'll be significant opportunities for
us, as a leading player in the space, to facilitate activity between our customers, buyers and sellers, and there should also
be a significant opportunity as a distressed investor in this market.
Investment banking revenues -- clearly banking activity has slowed down significantly with the global credit crisis.
However, some important things. We think we've made a lot of progress in investment banking. The dialogue with
strategic investors is very strong. We maintained our focus on strategic investors throughout the last several years, so
we maintained that dialogue. We think that that will be very important as we move forward from here. There are a
number of opportunities. Our backlogs are building. Whether things materialize will really be a question of market
conditions.
In the financial sponsor space, we think our business there is significantly improved from where we began this
cycle, with our sponsor relationships much deeper, in a much better position moving forward with an investor base that
is certainly going to be active in the months, quarters and years ahead.
In wealth management, this area doesn't get a lot of focus, but it is important for us. We had a very strong year in
the private client area last year. The asset management areas, clearly, took a big hit in the third quarter, with the
difficulties with the two High-Grade hedge funds. Importantly, we've changed management there. We think we've
stabilized the platform in asset management.
When you-- when you-- we had about $170 million of losses that we took in the third quarter related to those funds,
both from the write-off of fees that were receivable from the funds, as well as losses on the repo activity that we did.
But, again, if you normalize for that, you can see the business id running at almost a $1 billion level across the two
areas.
In PCS, $600 million of revenues, less than 500 brokers, over $1 million of average production per broker. High-
net-worth business, a significant increase in fee-- stable fee revenues. You can see that almost a third of revenues or
over a third of revenues are coming from fee-based activities. So an area that we are very focused on continuing to
expand and grow.
In the asset management side, assets under management, while they're down from their peak in '06, that is largely a
function of the spin-out of one manager, O'Shaughnessy, O'Shaughnessy Asset Management, that spun out in the fourth
quarter. We continue to have a financial arrangement and interest in his activity, but that was the big drop in AUM.
Other than that, alternative assets have hung in pretty well. We've got about $8.5 billion of alternative assets. And
we really, somewhat to our surprise, considering how significant the failure of the High-Grade funds were, alternative
assets under management, as well as other assets under management, really stabilized in the fourth quarter. We did not
see significant outflows, for the most part, and we think that, together with the leadership changes there, we've got the
franchise pointed in the right direction as we go into '08.
I've talked a lot about international, so I'll just kind of skip over this, but as you can see, very strong growth in the
international area. We're building out across the board in equities and fixed income, beginning to build out a greater
banking presence.
One thing that I do want to talk about just before we wrap up and go to Q&A, is our joint venture with CITIC
Securities. As we looked at our Asian operations, we felt that, as we tried to get more exposure to the China market, the
best way for us to do this was in a collaborative way with another local player. Too difficult, in our opinion, to try to
build out the presence necessary to be a significant player.
It's a fantastic opportunity with CITIC Securities. CITIC Securities, as I think you all know, is the leading
investment bank in China, leading player in their IPO market, very sizable sales force, largely retail-oriented. During
the-- during the fourth quarter we announced a joint venture with them where we will joint venture in Hong Kong with
them. All of our Asian operations will be joint ventured with them, so our non-China activity in Hong Kong, our
offshore business.
We announced a collaboration agreement with them onshore in China, where we will assist them in building out
their institutional businesses in both equities and fixed income and derivatives. We have a profit participation in that.
And we have a $1 billion-plus investment agreement where they will invest $1 billion in us in a trust preferred--
convertible trust-preferred security. We have a $1 billion investment in them in a convertible bond and warrant
structure.
 We think that this transaction will transform our business in Asia, provide us with a significant platform for growth,
going forward. The joint venture, while it is not completely executed and the investments haven't yet been made as we
continue to make our way through the regulatory process, we think the opportunities here are very significant. We've
been working with our partners. We see a very big opportunity in the investment banking area, as well as in the sales
and trading areas and we're quite excited about that.
So just to wrap up before I open up to some questions, a very tough year, a tough operating environment. We're
dealing with it. We think the franchise is strong. We think that we have made the right decisions to stabilize the balance
sheet.
The capital base is in good shape. We think that the business is, while we're going to deal with a very choppy
environment, certainly, for some period of time here in '08, we think the revenue-generating capacity of the business is
firmly intact. If we can stabilize the more problematic areas of-- in asset values around our mortgage area, we think that
we've got the business poised to have a reasonable 2008, given the operating environment we're in and what I mean by
that is kind of inside of the historical range of ROEs that we would expect in a tough operating environment.
So with that, why don't I take some questions?
SUSAN ROTH KATZKE: Great. If I-- if I could start off with the first question here. Currently, the credit markets
are fairly seized up. There's a lot of talk about a lot of liquidity on the sidelines and you maintain a net short position
against the subprime exposures. How do you know, given kind of the supply/demand imbalance in the credit markets,
how do you know when to reverse that position of being net short?
SAM MOLINARO: Yes, well, that's a good question. And when we disclose that net short position I don't want
you to assume from that that we just have a speculative position short the subprime market. That net short is part of our
larger hedging strategy against the rest of our mortgage assets.
But this has been, certainly, the big question is how to hedge these exposures. Unfortunately, there are no perfect
hedges. There are significant basis risks in many of the differing hedging strategies that we're all trying to execute and,
as a result of that, there's likely to be a fair amount of earnings volatility from trying to insulate these portfolios against
further fundamental deterioration.
So it is-- it is challenging. I think, though, unfortunately, we all find ourselves-- the industry is in an environment
where it's going to be heavily driven by trading decisions over the course of, certainly, the first quarter and probably
into the second quarter. But that is a significant challenge that is being dealt with, is the basis risk in hedging both
residential mortgage assets, leveraged finance pipelines, leveraged finance balances, commercial mortgages -- you can
really go across the board.
It's interesting. The advent of the ABX and CMBX and all these different indices where, generally speaking, there's
very little trading volume, have really driven the market across a lot of the cash products. With a lack of liquidity and
very little cash trading activity, this has become a very big factor in how we're all trying to manage and hedge our
exposures.
SUSAN ROTH KATZKE: Okay. With that, we have covered a lot of ground.
SAM MOLINARO: Yes, thank you.
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LOAD-DATE: March 20, 2008