Filed by Lehman Brothers Holdings Inc.
Pursuant to Rule 425 under the Securities Act of 1933
Subject Company: Neuberger Berman Inc.
Commission File No. 001-15361
Date: September 24, 2003
The attached document contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements include, but are not limited to, (i) statements about the benefits
of the acquisition of Neuberger Berman by Lehman Brothers, including financial
and operating results, synergy benefits and any accretion to reported earnings
that may be realized from the acquisition; Lehman Brothers' and Neuberger
Berman's plans, objectives, expectations and intentions and other statements
contained in this presentation that are not historical facts; and (ii) other
statements identified by words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" or words of similar meaning. These
forward-looking statements are based upon management's current beliefs or
expectations and are inherently subject to significant business, economic and
competitive uncertainties and contingencies and third-party approvals, many of
which are beyond our control. The following factors, among others, could cause
actual results to differ materially from those described in the
forward-looking statements: (1) whether the stockholders of Neuberger Berman
approve the proposed transaction; (2) the satisfaction of the other conditions
specified in the merger agreement, including without limitation the receipt of
required governmental and other third-party approvals of the proposed
transaction; (3) the ability to successfully combine the businesses of Lehman
Brothers and Neuberger Berman; (4) the realization of revenue and cost synergy
benefits from the proposed transaction; (5) operating costs, customer loss and
business disruption following the merger, including adverse effects on
relationships with employees; (6) changes in the stock market and interest
rate environment that affect revenues; and (7) competition. Lehman Brothers
and Neuberger Berman do not undertake any obligation to update any
forward-looking statement to reflect circumstances or events that occur after
the date such forward-looking statement is made.
The attached document shall not constitute an offer of any securities for
sale. The proposed transaction will be submitted to Neuberger Berman's
stockholders for their consideration. Lehman Brothers filed a Registration
Statement on Form S-4, which contains a proxy statement/prospectus, with the
Securities and Exchange Commission ("SEC") on September 17, 2003. The
Registration Statement may be amended from time to time. Stockholders of
Neuberger Berman are urged to read the Registration Statement and proxy
statement/prospectus contained within it and any other relevant materials
filed by Neuberger Berman or Lehman Brothers with the SEC because they
contain, or will contain, important information about Neuberger Berman, Lehman
Brothers and the transaction. Neuberger Berman stockholders may obtain a free
copy of the Registration Statement and proxy statement/prospectus and other
documents filed by Lehman Brothers and Neuberger Berman with the SEC at the
SEC's Internet site (http://www.sec.gov/). Copies of these documents also can
be obtained, without charge, from Lehman Brothers, Investor Relations, 745
Seventh Avenue, New York, New York 10019 (212-526-3267) or Neuberger Berman,
Corporate Communications, 605 Third Avenue, New York, New York 10158
(212-476-8125).
Lehman Brothers, Neuberger Berman and their respective directors and executive
officers may be deemed to be participants in the solicitation of proxies from
the stockholders of Neuberger Berman in connection with the proposed
transaction. Information about the directors and executive officers of Lehman
Brothers is set forth in the proxy statement on Schedule 14A, dated February
28, 2003, for Lehman Brothers' 2003 annual meeting of stockholders.
Information about directors and executive officers of Neuberger Berman and
their ownership of Neuberger Berman common stock is set forth in the proxy
statement on Schedule
2
14A, dated April 16, 2003, for Neuberger Berman's 2003 annual meeting of
stockholders. Additional information regarding participants in the proxy
solicitation may be obtained by reading the proxy statement/prospectus
regarding the proposed transaction.
* * *
The following is the transcript of a presentation made by David Goldfarb,
Chief Financial Officer and Executive Vice President of Lehman Brothers on
September 24, 2003 at a conference call for investors:
Coordinator: Good morning and thank you all for holding. Welcome to Lehman
Brothers third quarter earnings conference call. At this time
all participants will be able to listen only until the question
and answer session of the conference. Also, today's call is
being recorded. If you have any objections, you may disconnect
at this time. I would now like to turn the call over to Ms.
Shaun Butler, Director of Investor Relations. Thank you, ma'am,
you may begin.
S. Butler: Thank you all for joining us this morning. Before we begin, let
me point out that this presentation contains forward-looking
statements. These statements are not guarantees of future
performance. They only represent the firm's current
expectations, estimates, and projections regarding future
events. The firm's actual results and financial condition may
differ, perhaps materially, from the anticipated results and
financial condition in any such forward-looking statement.
These forward-looking statements are inherently subject to
significant business, economic, and competitive uncertainties
and contingencies, and in the case of pending acquisitions,
certain conditions and third party approval, many of which are
difficult to predict and beyond our control.
For more information concerning the risks and other factors
that could affect the firm's future results and financial
conditions, see management's discussion and analysis of
financial condition and results of operation in the firm's most
recent annual report to shareholders and quarterly report on
Form 10-Q. For more information concerning the risks and other
factors that could affect the pending combination with
Neuberger Berman, read the registration statement and the proxy
statement/prospectus and any other relevant documents filed
with the SEC that may become available, as well as any
amendments or supplements to these documents. You will be able
to obtain a free copy of the proxy statement/prospectus, as
well as other filings containing information about Lehman
Brothers and Neuberger Berman, at the SEC's Internet site,
www.sec.gov.
This presentation contains certain non-GAAP financial measures.
Information relating to these non-GAAP financial measures can
be
3
found under selected statistical information in this morning's
earnings press release, which has been posted on the firm's Web
site, www.lehman.com.
Let me now turn the call over to Dave Goldfarb, our Chief
Financial Officer.
D.Goldfarb: Good morning, and thank you for joining our third quarter
earnings discussion and business update. Today I will review
our excellent financial performance for the quarter, provide
you with a brief outlook for the remainder of 2003, and then
turn the session over to questions.
Clearly, we began to see an improvement in both the overall
market environment as well as the macro economy last quarter.
These trends continued to pick up steam during the current
quarter. The U.S. equity markets hit a 14-month high in August
as GDP growth, corporate profitability, manufacturing indexes,
and capital spending all improved. Monetary and fiscal policy
provided additional stimulus in the form of a 25 basis point
rate cut and the positive impact of recent tax policy changes,
both with the objective of encouraging more rapid growth in the
U.S.
Europe seemed to follow the U.S. lead in terms of monetary
policy, as both the EBC and the Bank of England reduced
interest rates. European economic growth, however, continued to
significantly trail U.S. levels with three of Europe's major
economies, Germany, Italy, and Netherlands, all in recession.
However, anticipation of stronger U.S. growth prompted the
major European equity indexes to rally on the prospect of an
export-driven recovery.
Over the course of the quarter the Asian markets exhibited the
strongest equity gains, particularly in Japan, where stronger
GDP growth, increased corporate profitability, central bank
focus on deflation, and progress in bank reform caused the
Nikkei to soar over 30% off the 20-year low it had set in
April. Although the global economic picture slowly improved,
the market continued to face challenges, as treasury curves
steepened in the U.S. and Japan on the prospect of stronger
economic growth with no further central bank action and bond
market volatility soared.
U.S. and European equity volumes diminished in the usual
seasonal slowdown we see every August, despite high valuations.
This is not the case in Asia, where trading volumes remained
robust throughout the period.
4
In investment banking the picture was mixed, but the overall
outlook began to show slight improvement over the course of the
quarter. M&A completions remained extremely weak, although the
pace of announcement slowly picked up as the quarter
progressed.
Equity origination activity increased significantly to the
highest volumes since the second quarter of 2002. Issuance was
concentrated in secondaries and convertibles, while IPO volume
remained very light. In debt origination, volume continues to
be strong, although high-grade volume slowed somewhat from the
2003 peak levels due to the rise in treasury yields. High-yield
volume continued to grow as credit concern subsided, and
quarterly issuance hit its highest level since 1998. Overall,
market dynamics in the third quarter continued to improve, but
we still have to make further headway in order to get back to a
more normalized operating environment for equity origination
and M&A.
Given the strength and focus of our diversified businesses,
we're able to leverage this economic and market improvement and
translate it into extremely strong financial results.
Consequently, Lehman Brothers reported another outstanding
quarter. For the quarter we posted net revenues of $2.347
billion, an all-time record for the firm, and our second
consecutive quarter of record revenues, which is surely a
testimony to the strength of our franchise. This level
represents an impressive 74% increase over the prior year's
period and a 2% improvement over last quarter's strong
revenues. In fact, capital markets and investment banking, as
well as Europe and Asia, all posted their highest quarterly
revenues of the year. Within capital markets we realized our
fourth consecutive quarter of record revenues in fixed income.
This continued and significant growth in our top line
demonstrates the firm's ability to leverage any improvement in
the broader markets into revenue opportunities, particularly in
the capital market businesses where we've achieved significant
scale and breadth in our client-driven business platform. We
reported net income of $480 million for the quarter, which is
an increase of 147% year-over-year, and an increase of 10% over
second quarter net income, which included a $45 million
after-tax real estate charge. Our EPS was $1.81, representing a
159% increase over the prior year's period. Our pre-tax
operating margin was 31.9% and our return on equity was 20.7%,
surpassing last quarter's strong performance and representing
an important breakthrough to the
5
pre-tax and ROE metrics we were able to achieve two years ago
when the equity and M&A markets were far stronger.
As you can imagine, we are extremely pleased with these
results, especially given the continued challenges facing the
global economy. Our strong returns throughout the cycle
underscore the resiliency, as well as the depth and breadth of
our business platform, and again demonstrates the strength [of
the] revenue generating capabilities of our customer and
client-based business models across all market cycles. The
record revenues we've reported today are a clear confirmation
of the tremendous progress we've realized in our competitive
position as we continue to significantly raise our productivity
and the overall earnings capacity of the firm.
With that as an overview, let me review our results by
segments. First, in capital markets, which captures our
institutional and customer flow activities, our revenues
totaled a record $1.67 billion for the quarter, an increase of
129% over the third quarter of 2002 and up approximately 2%
versus the extremely robust second quarter of this year. These
results reflect exceptional strength in fixed income and an
ongoing improvement in equity market conditions. Among the
trends that typify the quarter were significant asset
reallocations from cash to equities, asset allocations between
various fixed income products in response to the backup in
treasuries and duration extension, and hedge adjustments by
investors, as volatility in fixed income and a need to protect
on the downside in equities prompted an increased use of
derivatives. Given the scale of our customer businesses, these
asset reallocations led to record volumes as we saw our
institutional sales volume jump 8% in the quarter from the
already strong levels we posted last quarter.
Our pre-tax profit in capital markets increased to $593
million, demonstrating the upsurge in activity this quarter,
along with a continued shift into high yielding products that
tend to generate higher margins. Our fixed income capital
markets businesses had outstanding results, producing their
fourth consecutive record rev[enue] quarter with $1.2 billion
of net revenues, a slight increase over last quarter, but a
125% increase over last year's third quarter, when the markets
were plagued with widening credit spreads and record defaults.
As I mentioned before, the spike in the 10-year treasury,
duration extension, and extremely high volatility drove record
trading volume, as investors transitioned between asset classes
and were
6
compelled to engage in more dynamic hedging. This manifested
itself in record customer-driven volumes and strong performance
in virtually every asset class in our highly diversified fixed
income division with significant gains in interest rate
derivatives, mortgages, high-yield, and municipals. In addition
to seeing these record flows, we continue to broaden the
breadth of our fixed income franchise, increasing the number of
active clients by over 4% in the current quarter. One area of
particular strength was interest rate derivatives, where the
volatility drove active hedging and the increases in treasury
mortgage rates for significant adjustments among duration
hedgers. The steepness of the yield curve prompted a heavy
usage of interest rate swaps and the periodic spikes in swap
rates also led to portfolio adjustments among LIBOR-based
investors.
We also saw continued strength in mortgages this quarter. The
origination market remained active. Refinancings hit their peak
in June, setting up a strong forward calendar of
securitizations which, for us, on the residential side, totaled
$23 billion. Increasing rates caused average duration to extend
from under one year to over three years. In the secondary
markets, this shift attracted a whole new set of investors to
mortgage assets, leading to heavy activity.
Our desire to take advantage of current rates also produced
significant CMBS volume in the quarter, and Lehman led
transactions with a total volume of $2.6 billion. Keep in mind
this is now a global market, and over the course of the quarter
we've structured CMBS transactions in Japan for Daito in an
apartment loan-backed MBS transaction and completed a real
estate securitization for Japan's Resolution and Collection
Corporation. We also arranged the first-ever Swiss CMBS
transaction in conjunction with PSP Swiss Properties.
Given the significant tightening in credit spreads, stronger
origination activity, and the search for incremental yields,
high-yield debt enjoyed very strong results in the quarter as
well. This was bolstered by positive fund inflows for much of
the quarter and an improved credit environment.
In municipals, state and local deficits drove a strong issuance
calendar, and the increased supply bolstered secondary market
activity and caused rates to back up. Consequently, investor's
demand for municipals also improved as these securities became
attractive from a relative value perspective.
7
Moving on to equity capital markets, our institutional revenues
total $476 million, an increase of 138% over the third quarter
of 2002, and a 6% increase versus the trailing quarter. As I
noted before, global equity markets rose during the quarter to
their highest levels in more than a year. Quarterly trading
volumes initially rose and then slumped to the lowest levels of
the year with the seasonal August slowdown. Nevertheless,
confidence improved in the marketplace, as improving corporate
fundamentals, coupled with a rise in the equity benchmarks, and
five positive months of fund inflows forced the long-only
investors back into the market as they sought to outperform the
broader indexes. This extended beyond the U.S. to include
Europe and, particularly, Japan, where the jump in the Nikkei
produced a significant influx of foreign investors to that
market. Consequently, the overall tone of the global cash
market has improved, and we saw a corresponding increase in
customer commissions over second quarter levels.
Equity derivatives experienced a stronger quarter on the basis
of a higher level of customer activity as clients increased
their use of structured hedging products such as options,
warrants, and equity-linked notes to hedge their downside
risk or reduce concentrations. The customer flow activity
associated with the Russell rebalance and our enhanced
automated market making and statistical arbitrage capabilities
also served to bolster results.
Moving on to investment banking, our net revenues were $453
million, the strongest revenues we've had in this business all
year, representing an 8% increase year-over-year and a 6%
improvement over last quarter. Our pre-tax profit in this
segment was $96 million, reflecting our high level of fee
revenues, with an improved contribution from equity
underwriting and a mix shift from high-grade to high-yield
origination that also strengthened margins. We posted M&A
advisory revenues of $102 million, down 13% year-over-year but
an increase of 10% compared to the trailing quarter.
Industrywide M&A volumes remained sluggish, with completed
transaction volumes down 24% versus the year earlier period,
and realizing an 18% decline from the already depressed second
quarter levels.
In equity underwriting our revenues were $119 million, up 28%
versus the third quarter 2002, and an increase of 59% over the
second quarter this year, as our market volumes rose to their
highest levels since the second quarter of 2002.
8
Our quarterly lead manage origination volume totaled $5 billion
and remained heavily concentrated in secondaries and
convertibles, which is consistent with our view toward the
necessity of corporate re-equitization and the desire of
companies to monetize their core shareholdings in the current
environment. This pattern was truly global in nature, and over
the course of the quarter we completed significant transactions
for clients in Japan, Korea, Spain, and Italy. The IPO market
slowly reopened in the quarter and we successfully launched
transactions for Netgear and Texas Capital Bancshares.
Our fixed income underwriting revenues during the quarter
totaled $232 million, up 12% year-over-year, but down 10% from
the very robust second quarter levels. Although high-grade
credit spreads tightened by 12 basis points over the course of
the quarter, the spike in the 10-year treasury, a temporary
widening of spreads, and record volatility slowed the pace of
issuance. Our lead manage issuance exceeded $18 billion for the
quarter, and much of that was swapped into floating rates to
take advantage of the steep yield curve.
Fundamentals in the high-yield market continue to improve, as
credit spreads tightened a further 143 basis points, reflecting
investors' demand for high yielding products and a general
improvement in credit quality, as demonstrated by lower default
rates. For the quarter we led managed a total of $2.9 million
of issuance, including significant transactions for PG&E,
United Components, and Williams Company.
It's important to note that we continue to make considerable
progress in our investment banking franchise, most evidently in
our market share and equity and underwriting, which continues
to improve. Our financial sponsor practice has continued to be
a mainstay of investment banking activity where, in this
quarter alone, we advised Carlyle in their acquisition of the
automotive parts business of UIS, we brought a secondary
offering for Carlysle's portfolio company, United Defense, and
we joint led a senior note issuance for Qwest Dex, a portfolio
company of Welsh, Carson and Carlysle. We also advised on
Madison Dearborn's purchase of Williams Energy Partner.
Our third segment, client services, delivered revenues of $227
million, up 14% versus the year earlier period and essentially
flat to last quarter. Our pre-tax profitability in this segment
was $60 million. These results were driven by our high net
worth distribution business, which produced the third best
quarter ever.
9
Sales of equity products to our net worth clients increased 15%
versus second quarter levels as market sentiment continued to
improve. The fixed income component of our high net worth
business also held at near record levels, with volumes slightly
down from the record we posted last quarter. As a result,
productivity held very stable, at a very robust $2 million per
broker.
Those are our results by business segment. Now I'll briefly
review the results in our non-U.S. operations. For the quarter,
our international revenues accounted for 35% of firmwide
revenues as both regions experienced significant improvements
over the prior periods. In Europe our results were particularly
strong in equities as higher valuation prompted a stronger pace
of activity in the cash markets. We also saw stronger
performance in equity and interest rate derivatives due to
higher volatility in both markets. In investment banking we
gained market share in both debt and equity originations over
the prior year.
As I noted before, in Asia we realized our strongest quarter
ever as our revenues more than doubled from second quarter
levels. The Asian markets rallied on significant volatility,
which benefited our equity derivative customer-driven business.
The rapid back up in JGB yields prompted an increasing use of
interest rate derivatives as clients sought to hedge their
exposures. In investment banking we realized a significant
improvement in market share in all products. For the quarter,
we achieved far stronger results than we've seen in some time
in both Europe and Asia.
Moving briefly to expenses, we have continued our disciplined
approach to expense management, which is one of our core
competencies. For the quarter we recorded a comp and benefit
ratio of 50%, slightly less than the compensation ratio we have
previously posted. Our headcount increased to approximately
14,500 by quarter's end. In addition to our normal seasonal
increase in the new class of analysts and associates, we also
acquired another residential mortgage originator, which added
to our total. Like our transaction with Aurora last quarter, we
believe that this acquisition adds long-term value to our
mortgage franchise by allowing for further vertical integration
through the sourcing of product for our securitization
pipeline.
For the quarter, our non-personnel expenses totaled $424
million, an increase of 2% over second quarter levels. Variable
expenses related to brokerage clearance and exchange fees
increased due to the significant expansion of fixed income
volumes, particularly in
10
the areas of derivatives, structured credit trading, and
futures. Expense management remains a significant focus at
Lehman and we continue to exert strict control over our
non-personnel expenses as we constantly strive to make our
expense base as efficient as possible.
Taking all this into account, we recorded a pre-tax margin of
32% for the quarter. Our tax rate was 33.4%, slightly higher
than in previous quarters due to the higher level of pre-tax
income and the diminished impact of tax preference items
relative to this higher base. We also needed to true up our tax
rate to accrue it to an approximate 30.5% annual rate, which we
expect for the full year given the higher level of pre-tax
income we are reporting. Net income was $480 million for an
annualized ROE of 20.7%.
These are terrific results which clearly demonstrate the
diversity, scale, and capability of our franchise across
products, clients, and regions. These record revenues are a
clear indication of the value of our customer flow business,
which has performed strongly throughout the cycle as our
institutional and high net worth clients continue to transition
between asset classes and look to preserve their performance by
hedging their risks.
While we are pleased to report significant revenue increases in
virtually all our business segments this quarter versus the
sequential period, we are particularly mindful of the
improvement in equity origination and sales and trading because
we believe this to be the business with the strongest potential
for growth in the coming quarters.
Let me make a few comments about our balance sheet and risk.
During the quarter we increased our equity base by 7% and ended
the period with stockholder's equity of $10.3 billion and total
capital of approximately $53 billion.* Our net leverage, and by
that I mean assets less the matchbook divided by equity and
trust issued securities, was 16.8 times* lower than in our
established
______________
* The following presents, for total capital and net leverage, the most
directly comparable financial measure calculated and presented in
accordance with GAAP and a reconciliation of the differences between the
non-GAAP financial measure with the most comparable financial measure or
measures calculated and presented in accordance with GAAP. This note was
not a part of Mr. Goldfarb's oral remarks.
At August 31, 2003, long-term debt was $41.8 billion, total stockholders'
equity was $10.3 billion and trust issued securities subject to mandatory
redemption were $1.0 billion. Total capital includes long-term debt,
total stockholders' equity and trust issued securities subject to
mandatory redemption. The Company believes total capital is useful to
investors as a measure of the Company's financial strength.
At August 31, 2003, total assets were $295.0 billion and matched book was
$105.0 billion; total leverage (total assets divided by total
stockholders' equity) was 28.7 times. Net leverage is defined as total
assets excluding matched book divided by total stockholders' equity plus
trust issued securities subject to mandatory redemption. The Company
believes total stockholders' equity plus trust issued securities subject
to mandatory redemption to be a more meaningful measure of the Company's
equity for purposes of calculating net leverage. Matched book represents
securities purchased under agreements to resell ("reverse repos") to the
extent such balance is less than securities sold under agreements to
repurchase. Certain rating agencies consider such reverse repos to be a
proxy for matched book assets, as such assets are considered to have a
low risk profile, and exclude such amounts in the calculation of
leverage. Accordingly, the Company believes the ratio of total assets
excluding matched book to total stockholders' equity and trust issued
securities subject to mandatory redemption is useful to investors as a
more meaningful measure of the Company's leverage.
11
targets. Our [debt] was essentially flat to last quarter's
levels and from a rating agency perspective, Moody's placed us
on review for possible upgrade and S&P raised its outlook on
our A credit rating to stable from negative, both positive
developments from a funding and counterparty perspective.
Lastly, over the course of the quarter, we repurchased a total
of 4.3 million shares at an average price of $67.26.
Let me briefly highlight what we have accomplished this quarter
in terms of building the franchise for the long term to better
position ourselves for even better core cycle performance. To
this end, over the course of the quarter, we announced or made
several acquisitions, both large and small. We made a series of
great hires and we continue to grow organically by attracting
an extremely talented group of new analysts and associates to
the firm. By far our most significant announcement over the
period was an agreement to acquire Neuberger Berman. We
announced this transaction in July and expect to close sometime
during our fourth quarter. This is a great transaction for the
firm and one that is well aligned with our strategic and
financial objectives.
We believe the Neuberger combination will do the following:
transform our high net worth client platform into one of the
leaders in the industry, bring our scale in this business to a
whole new level, and give us increased revenue diversification,
less revenue to volatility, and an incremental source of high
and sustainable margin. We're very pleased with the response to
the transaction which we are receiving from Neuberger's
employees and clients.
To ensure seamless integration, we've assigned a large number
of Lehman and Neuberger people to a total of 25 teams. We've
also seen a number of inquiries occurring between the two
platforms,
12
which bodes very well for cross-selling opportunities upon
closing. So we are very pleased with the progress we have made
to date towards this combination and Neuberger's assets into
management continue to grow and are currently approximately $66
billion.
Last week we announced a smaller transaction, the acquisition
of Crossroads Group, a manager of approximately $2 billion in a
family of private equity funds. This is a meaningful
acquisition for our private equities division which would bring
our assets under management under private equity to
approximately $7 billion.
In addition to these transactions, we've continued to attract a
number of experienced senior people to our business. During the
quarter we recruited a new global head of equity trading, a new
global head of the healthcare investment banking group, and in
Japan, a new head of equity cash and program trading. In Europe
we continue to add in areas such as foreign exchange and equity
derivatives and we named our first non-U.S. director to our
board of directors, Christopher Gent, the former CEO of
Vodaphone. So we continue to make great progress in bolstering
our competitive positions.
Before we go to questions let me briefly discuss our outlook
for the coming months. Clearly, activity within our industry
remains highly linked to global economic growth both in banking
and in capital markets. Our expectation is for the U.S. GDP to
increase by approximately 5% in the third quarter, 3.5% in the
fourth quarter, and approximately 3.6% next year. We anticipate
positive but much more moderate rates of growth in Europe, but
have revised our growth expectations for Japan upward to 2% for
the fourth quarter and for 2004.
Given the fragile nature of the recovery, we expect fiscal and
monetary policy to remain supportive. Despite the recent jump
in rates, we expect the interest rate picture to remain fairly
benign. In fact, we expect an additional 50 basis points in
rate cuts from the ECB and we don't anticipate any rate
increases from the Fed until September 2004 at the earliest.
Under these interest rate scenarios we anticipate global fixed
income issuance, which includes governments, agencies,
corporates, municipals, mortgages, and asset-backed's, to reach
a record of $8.7 trillion in 2003. In our initial bottoms-up
analysis we are projecting 2004 origination to drop
approximately 10% with the weaker mortgage and high-grade
origination partly offset
13
by higher levels of sovereign, high-yield, and asset-backed
offerings.
In terms of fixed income capital markets, fundamentals remain
in place for a continued strength in our customer franchise.
Globally, fixed income has grown approximately 40% since 1999
to a market size of over $17 trillion on the basis of this
intermediation, newer asset classes, and structural change.
Given the sheer size and diversity of this marketplace and the
natural flow of cash and coupons inherent to these securities,
it is our strong view that the baseline level of fixed income
flows has permanently increased well beyond what we've seen in
the past.
It is important to note that interest rates are not the only
driver of fixed income activity, just as we saw this past
quarter. Even more important drivers have been the high degree
of volatility present in the fixed income markets today, the
shape of the yield curve, and the general improvements in
credit quality and credit spreads. These factors that determine
which asset classes dominate client portfolios and how they are
hedged had a significant impact on our third quarter trading
volumes and these factors are also key determinants in terms of
trading activity for the current quarter and for next year.
Consequently, our overall outlook in fixed income remains very
positive.
In equities our outlook has also become more positive, although
we remain in the early stages of a recovery. Equity fund flows
have been positive for five months in a row, generating
stronger activity from the long-only investors in a market
that had been largely dominated by hedge funds. With market
appreciation and diminished volatility, the equity origination
markets have become more active and volumes increased fairly
significantly over the course of the quarter until we hit the
August slowdown.
Underwriting activity has been heavily dominated by secondaries
and convertibles, consistent with the de-leveraging thesis we
have put forward in the past. We continue to see issuance
increasingly use shelf registrations to execute overnight deals
or accelerated book builds, which have tended to understate the
pipeline data. However, despite the fact that the equity
pipeline is somewhat less reliable, we have witnessed an
improvement in this measure as well.
Our pipeline of lead manage filed and yet to be filed
transaction volumes has jumped 7% this quarter to $6.2 billion
today. We rank third in terms of filed transactions and IPO's
comprised
14
almost 70% of that total, where we ranked fifth. So progress is
continuing and we continue to grow our market share in equity
origination.
In M&A we continue to see a high level of activity among the
financial sponsors, where we have established significant
market share. Additionally, corporations continue to be
extremely interested in divestitures as a means of reducing
excessive debt levels, cleaning up their balance sheets, and
streamlining their organizations.
Industry-wide, we have started to turn the corner with M&A
announcements finally exceeding completions, thereby allowing
pipelines to gradually build. This is off a much smaller base
and realistically it will take a while for the return of the
strategic buyer. In fact, if we look at M&A activity coming out
of the last recession, it took approximately nine quarters for
M&A to reach more normalized volumes relative to GDP. In terms
of our own outlook, we feel we are extremely well positioned
for any incremental recoveries in equities and M&A. Let me
point out that at the top of the cycle, in our peak revenue
year of 2000, we achieved record revenues in equities and
investment banking with considerably less market share and
capacity than we have today.
Given our outlook for the remainder of 2003 and into 2004, we
intend to focus on continuing the build-out of our diversified
business model with a focus on sustainable revenues, and
closing and successfully integrating Neuberger Berman in order
to reap the full benefit of its growth potential along with a
lower revenue volatility and revenue expansion that I described
earlier.
We also intend to continue to focus on driving excellent
creative and tailored solutions to our client complex
requirements; controlling our expenses; remaining
conservatively positioned around risk and liquidity; optimizing
our use of capital, balance sheet, and equity; realizing high
productivity from all of our people and the appropriate
efficiencies from our technology investments; gaining
incremental market share in both investment banking and capital
markets while focusing our share of wallet from a growing
client base; and lastly, striving to achieve top of peer group
financial performance.
Let me conclude by stating that we are extremely pleased with
these terrific results. This performance clearly demonstrates
that we have continued to significantly elevate the earning
capacity of the firm and are delivering on our key objective to
maximize
15
shareholder value in any market environment. Finally, they
demonstrate that we remain strongly positioned for further
recovery in the broader markets. Now let's turn it over to
questions.
Coordinator: Our first question comes from Guy Moszkowski. Sir, you may ask
your question.
G. Moszkowski: Thank you. Good morning. Great results. A question for you. You
talked about M&A coming back slowly in terms of the strategic
buyer. Can you give us a little bit more color broadly on the
types of discussions that you're having at least with the
financial sponsors that you're a little bit more positive on?
D. Goldfarb: As I mentioned, we finally are seeing announcements starting to
exceed completions, so there is a gradual build-up. We do think
it's going to be a little while still until we return to more
normalized levels. However, in the interim, there certainly are
certain sectors that have excess capacity in them. These are
the sectors we all know, like telecom, like technology, like
energy, and we continue to be very active in those sectors. We
also, to your point, remain very active with financial
sponsors. The trend we have seen over the last 18 months there
is that continually, they're looking to diversify
geographically as well, and we continue to be very active in
Europe as well as Asia. We kind of see it in all regions and in
the sectors that right now have a significant amount of excess
capacity.
G. Moszkowski: Looking a little more short-term and turning to debt markets,
you gave, obviously, a very articulate and very bullish outlook
for the next year or two there, but in terms of the fourth
quarter, should we expect what has historically been a seasonal
downturn in that market just given activity patterns of the buy
side in fixed income, or is there some reason to believe that
this year that wouldn't materialize?
D. Goldfarb: I think the fixed income market, what we have seen throughout
the last two and a half years, has significantly changed in
scale and scope. The whole ... function that firms like us
provide has continued to grow. We believe while certain
products in fixed income will always have their peaks and
valleys, for instance this past quarter, in June, we had record
levels of mortgage residential refinancing that started
trailing off. You can expect to see some slowdown in that area.
There are quite a few other products, though, which are in
growth stage. If you do look at asset-backed's, you look at
commercial mortgages, some of those
16
products have actually not been very active and haven't
participated very actively in the recent low interest rate
environment. Given the depth and breadth and scale of the
global fixed income marketplace, we believe it's going to
remain resilient.
G. Moszkowski: You wouldn't plan for even a seasonal slowdown in the
fourth quarter at this point?
D. Goldfarb: There always are certain seasonal slowdowns in certain specific
products. It's hard to see peak volume recurring every quarter,
but at the same time we believe we've seen kind of a permanent
change in shift in the fixed income markets and we believe it's
going to remain active. Less active than seasonal slowdowns,
but it's going to be remaining quite active.
G. Moszkowski: That's helpful. Finally, I know this is very small, but you did
acquire another one of these mortgage originators. I don't know
if we really understand very much about those. Can you just
give us a little nutshell comment on what the economics, the
financial economics are of an acquisition like that?
D. Goldfarb: Sure. For us, that really is part of a broader plan continuing
to vertically build out our mortgage business. We have been a
strong participant and a strong originator of mortgage products
for years. The strategic rationale for acquiring the platforms
themselves is to secure the source of supply. It's really that
simple. These are originators. They originate the mortgages. It
basically goes through our pipeline. We securitize it and it's
part of our customer facilitation business in mortgages, which
has helped us continue to grow market share over time. We
really are, by purchasing these platforms, just securing
sources of origination.
When you think about the economics of that, to us it's really
in context to our broader mortgage economics, which continue to
be one of our strong contributors in our fixed income business.
G. Moszkowski: Thanks very much, Dave.
Coordinator: Henry McVey, you may ask your question.
H. McVey: Good morning. Just a couple quick questions. On comp and the
tax rate, if you think about the business model, you've added
Neuberger, you're going to have Crossroads, you have Aurora,
you have other mortgage originators. Can you bring the comp
rate
17
down below 51% on a sustainable basis going out to 2004? Also,
what does that mean for the tax rate in 2004?
D. Goldfarb: As far as the tax rate, the tax rate for the quarter was
slightly elevated. As you know, it's the reverse of the
explanation that I've been giving the last six quarters. As
pre-tax income changes, the effect of our permanent benefits
gets diluted or gets accentuated. This quarter we obviously,
this year, for nine months, have much higher pre-tax income, so
the benefit from our permanent items, which are really things
like municipal interest, DRD, become more diluted and therefore
in and around the earnings that we have reported so far this
year, we would see our tax rate being in and around 30.5%.
That's what we're truing up to this quarter.
Given the overall size of our firm, even with Neuberger and the
other small acquisitions we've done, pre-tax income drives more
than those activities. In the range of the economics we're
reporting today you can expect a tax rate in and around the 30%
to 31% range.
From a compensation and benefit perspective we brought our
compensation and benefit rate down to 50% this quarter, and
that was really all about, given our results so far through
nine months, given our anticipation where we believe we'll be
for the year, given the competitive pressures we have out
there, and also taking into consideration the fair compensation
we think we should pay our people, it seems that in and around
50.5% for this year is what we're going to need to fairly
compensate our employees who've generated the great economics
that we're reporting today.
As we, again, go forward with different platforms, certainly
you could expect to see some slight decreases from those levels
as the firms we bring in have a compensation and benefit ratio
that is slightly less than the 50%-51%.
H. McVey: Just two other quick questions. One, if you think about the way
the model is changing, you're starting to vertically integrate
and that's how you've been using your capital. Do you want to
digest what you have right now or do you want to continue to
build out? The skeptical side of me is when you say that we're
at permanently higher levels on fixed income. How much of that
is just a function of a steep yield curve and that there are
just greater volumes out there? We've heard that before on the
equities side and it ended badly. Can you help me just feel
more confident about that statement?
18
D. Goldfarb: On the strategic question first, we have aggressively, over the
last couple of years, attempted to build additional scale into
our business platform. That's partly what has generated the
economics we've had so far this year. We're very comfortable
currently with our scale. Once we digest Neuberger and
successfully integrate that great franchise with our franchise
we'll be up to around 16,000 employees. With the 16,000
employees, we think that's in and around the right size for us
right now.
Having said that, if a great opportunity shows up, we certainly
would look at it, but certainly, we're getting more comfortable
with our relative scaling at around 15,000. As far as the
vertical integration, again, the couple of platforms that we
added this year, it's not necessarily end game, but there's not
a gigantic expansion model being built in there. So we're
comfortable where we are right now.
As far as fixed income, when I mentioned before that we think
we're seeing a permanent change, what I mean is, from my
earlier comments I made before to Guy, it ... permanently that
you can always have record volume every quarter. There are
certain environments in fixed income which will always
basically lead to more activity in certain products in fixed
income. However, though, the client base, the investor base at
both the institutional level and the high net worth level, we
think the mixed change is a permanent change. Fixed income,
across cycles, we believe will be a slightly higher percentage
of the mix than it historically has.
As far as the steep yield curve, that certainly benefits
certain products, like short-term funding, repo's, and
businesses like that, but again, it's not necessarily the sweet
spot for all the asset classes. We do think that the customer
volume, the customer requirements, volatility, is really what
drives this. What we saw this quarter when we had the big
backup in rates at the end of July, a lot of people weren't
sure what that would mean in fixed income capital markets. What
it means is that people, clients, institutions have large fixed
income portfolios. Overnight, they won't liquidate those
portfolios. They need to readjust the hedge ratios. They need
to basically take care of duration risk. The increased
volatility is going to mean continued people realigning risk,
aligning up risk appetite, and again, therefore estimates
continue to lead to increased volume from what we've seen
historically, but that doesn't mean every quarter peak. It does
mean a cross-cycle stronger level than we historically have
thought about.
H. McVey: Thank you.
19
Coordinator: Ken Worthington, you may ask your question.
K. Worthington:Hi, good morning. Can you update us, broadly speaking, on where
customer trading activity and volatility in fixed income stands
today versus average third quarter levels? Which fixed income
products are the greatest opportunities near-term for you? You
said CMBS and commercial mortgages haven't really been a factor
thus far. Are you seeing a pickup in activity in those
products?
D. Goldfarb: We're still broadly, when you look at the marketplace, and we
obviously participate in the marketplace, if you look at
current activity, overall, fixed income volume flows remain
strong. Certainly, as I mentioned before, we continue to see a
pickup in high-yields on both the origination and secondary
side. CMBS, we did a couple of large deals in the third
quarter. We still believe that is an asset class that really
hasn't participated in the overall fixed income uplift that
we've seen, so we continue to expect to see strong performance
there. Even with rates going a little bit up, they're still
pretty low by historical standards. Even though high-grade
certainly will be off its record levels from both an
origination and secondary perspective, we still think that
marketplace will remain quite active as well.
We still think we're going to see significant activity across
the broad array of fixed income asset classes and a couple of
specific asset classes that I mentioned before, we think
probably will have the greatest growth where we still expect
strong contribution from the other asset classes as well.
K. Worthington:Where was VAR this quarter versus last quarter in fixed income
products?
D. Goldfarb: VAR overall for the firm was around flat. Within fixed income
it was flat as well.
K. Worthington: Thank you.
Coordinator: Glen Schorr, you may ask your question.
G. Schorr: Hi. Thanks. Just one follow-up. Your comments on leverage
earlier, you remain in the comfort zone but you're at the
bottom end of the zone when fixed income is running off the
hook. I'm just curious on how that happens in such a strong
fixed income quarter and maybe just follow-up thoughts on
capital use if fixed income ever moderates in our lifetime.
20
D. Goldfarb: As far as the net leverage being approximately 16.8 times,
certainly that is kind of the lower range of what we have
reported over the last couple of years. Our balance sheet, I've
mentioned this three times in the past, is really driven by how
active our clients are. Certainly in fixed income we did see a
lot of that activity. As I mentioned in August, we typically
see a slowdown in equities. That was no different this quarter.
So even though fixed income remains at the same level, you
would normally expect to see a trail-off at the end of August
in some of the equity products.
Overall, we haven't had a change in strategy of how we use our
balance sheet. As you remember, net leverage is, on a ratio,
off of equity base. We've also ... our equity base during the
quarter. Even though our net leverage is down a little bit, our
absolute balance sheet level is pretty much around flat.
G. Schorr: Just a follow-up on the thoughts on the fixed income, if it
ever moderates off these record highs, which we feel it has to
at some point. Where does it go? In other words, do you allow
your leverage ratio to slip down to 14 to 15 times? How does
that get redeployed? Obviously, you had earlier comments on
acquisitions, but in other words, are there buy-backs in the
quarter, are there buy-backs in the future?
D. Goldfarb: During the quarter we bought back approximately four million
shares, which is pretty consistent with how we've been handling
our stock buy-backs for several years right now. Glen, we look
at our balance sheet and it's really quarter-to-quarter. It's
going to vary month-to-month. It's going to vary a little bit
predicated on which asset classes are very, very active. Even
though the overall pace of activity could slow, we continue to
increase our market share across a lot of the fixed income
asset classes.
Hopefully, as there is a slight drift-off in volume in some
asset classes, we're hoping that our market share, our client
activity increases, which more than offsets that. We're
comfortable with our balance sheet levels right now, we're
comfortable with our overall leverage ratio right now, and we
would like to continue to deploy capital to help ... our
clients activities in a risk mitigation type of way, which is
the way we run our capital markets business. It's not
necessarily going to drop off if we do a great job and are more
relevant to more clients and get a higher share of their
wallet. Hopefully they'll offset each other.
21
G. Schorr: The last follow-up on the mortgage company commentary, just in
terms of adding on fixed infrastructure towards the tail end of
the cycle, obviously the mortgage business is usually scaled
pretty well towards the end of the cycle. Is that already
starting in your now vertically integrated operation?
D. Goldfarb: Yes. It's important as you build up an infrastructure in that
type of business to keep the expense base as variable as
possible, which we have done though the core structure of those
types of entities. Certainly looking at just the refinancing,
which has just been one indicator, because obviously there's
new housing and things along those lines, certainly we're off
the peak of the refinancing index and we would expect to see
some slowdown there.
However, again, the purpose of those acquisitions is to try to
get us to improve overall market share, so hopefully we'll
continue to get a bigger piece of potentially a slight reducing
industry volume.
G. Schorr: Got it. I do appreciate it. Thanks. Great quarter.
Coordinator: Richard Strauss, you may ask your question.
R. Strauss: Dave, just a couple of questions, one on your view of interest
rates. I'm just curious. When was the last time you saw 5% GDP
growth and close to 4% next year, because I think that's what
you're looking for, and a sustained 1% Fed funds. I think in
1994 when GDP crossed 3% and he thought that was going to be
there on sustained level, that that's really when he made his
move. What would it take, given these numbers, for you to think
that he would move sooner than that, the Fed chair?
D. Goldfarb: It's been an interesting recovery to date as certainly, we've
seen corporate profitability start to improve, we've seen some
macro indicators of economic recovery happening. Obviously, we
know parts of the recovery really haven't participated yet,
like labor, which is kind of a good thing. We're also starting
to see the build up of some deficits, which to your point would
lead to further concerns down the road. We think right now the
policy is very focused on a real sustainable recovery and we
think that both monetarily as well as fiscally we're going to
have favorable activity that is going to contribute to the
growth. We just think even with it, the overall inflation
levels, given the fact that labor's still as weak as it is, is
going to stay in the low 1% to 2% level. As long as that
happens, there is going to be zero reasons to increase rates.
We think that rates eventually will start increasing again, and
certainly some of the deficits and things that are happening
...
22
build up will contribute to that longer-term, but we do think
that's more of the year and a half, two years out than we do
think it's something that's happening right now.
If there was, all of the sudden, a sudden gigantic recovery in
labor and it became more global ... the world, we have a
situation that some of the largest countries in Europe are
still causing a recession. It ... globally participated in. We
think it's going to have to be broader contributed, have labor
and jobs significantly participate in it, and have the growth.
Our growth will contribute to some importing, which will help
the exporting countries in Europe. As they start to participate
in some broader economic growth, we'll have a larger
participation.
In the environment we see, as I just outlined and described, we
think that, again, at the earliest it would be towards the end
of 2004 until the Fed would seriously consider increasing
rates. It's a different recovery. It's just a different
environment than we've seen before.
R. Strauss: Right. Just a final question, changing gears. It looks like
your private client margin went up another 100 basis points. I
think it was up 500 basis points last quarter. You said you
feel you can get to much higher levels with Neuberger. Are you
targeting a number? I think it's about 26% right now.
D. Goldfarb: Yes, it's up slightly versus the trailing quarter and pretty
much flattish with last year. I think that's being driven by a
little more equity and a little less fixed income. Certainly,
as we integrate the Neuberger platform into that, we would
expect that to go higher. We don't have a specific number in
mind, but in the high net worth money management platform
business, definitionally we'll increase that pre-tax margin
rate.
R. Strauss: It could be well above 30.
D. Goldfarb: It should be well above 30.
R. Strauss: Great. Thanks a lot.
Coordinator: Daniel Goldberg, you may ask your question.
D. Goldberg Good morning. Just continuing on the acquisition questions,
obviously within asset management or client services you're
going to link in Neuberger and now Crossroads. Can you comment
there on what other areas you're looking to do within the asset
23
management, more the fee-based revenue, what your strategy is
there?
D. Goldfarb: Our strategy remains consistent with what it's been. We're
trying to grow scale in that business to be akin to the scale
we have in some of our other businesses in capital markets and
investment banking. In Neuberger we were looking to build out a
high net worth platform, looking to build an equity asset
management platform, and as we've mentioned on this call and I
mentioned in our conversation we had in July, we think we found
a great partner and a great mix.
In Crossroads, different business. We had a private equities
business, which is in and around $4 billion to $5 billion
assets under management. We found, in Crossroads, a great
business platform which basically did a fund-of-funds type of
business we thought was a natural combination and elevation to
the business we had there. Again, we love the economics in both
those because, obviously, it gives us a ... type of revenues,
we get fees off assets under management. We would like to
continue to grow scale in that business. We don't have a
particular growth target. We're comfortable with those
acquisitions, with the sizing we have. However, we continue to
look at ways to grow it. If we can find additional
opportunities which were accretive, we would look at them.
Right now, our first order of business is to integrate
successfully with Neuberger, and we're going to take the time
and effort it takes to do that. As we do that, we'll continue the
... of other growth opportunities.
D. Goldberg: You mentioned in your prepared remarks that Asia had a record
quarter. We recently saw that you were in the process or you
had sold your title and operations. I know they're quite small.
I just wanted to see what the strategy is there and any
economics you can provide to us with that.
D. Goldfarb: Asian strategy has been very, very consistent. We have around
1,100 people in Asia, mostly out of Tokyo. The strategy for us
has been try not to be all things to all people in all products
and focus on the areas where we thought we could bring unique
value through our global strength into the region. We have
focused largely on restructuring opportunities. We have focused
on helping financial institutions monetize the less liquid
assets on their balance sheets, a lot of the NPL issues. We
continue to leverage off a lot of our structuring and
securitization and distribution capabilities to help alleviate
some of those concerns.
24
During the quarter we continued to see activity there. We
continued to see, as a result of some of the bank reform,
helping some of those institutions monetize their balance sheet
or mitigate their risk. It's a great business for us. It's
client advisory type of business for us. ... this quarter,
which is the one change we've seen, is obviously with a very
robust equity market. The equity market was robust not only as
far as return, and the ... was up over 20%, but the volume
itself was up over 50% during the quarter. Certainly, we were
able to take advantage of all that activity and all that flow
and increase our client activities around our equity
businesses.
A lot of our businesses in Asia talk to helping rehabilitate,
restructure balance sheets, help to advise on sales of
cross-holdings and activities along those lines. Again, it
continues to be very consistent with what it's been for the
last several years. Certainly, this time in the market we just
had a combination of equities being strong as well. So we
continue to broaden out. We've had some key hires, as I
mentioned before, in Asia. We hired a new head of Asia equity
business, again, last year. As I mentioned before, we hired
somebody in equity business this year. Our franchise continues
to grow and we continue to get more relevant to more clients.
D. Goldberg: Finally, you talked about efficiencies from technology
investments. What's the latest on that front?
D. Goldfarb: It's an every day 24/7 activity. Certainly, we've invested in
technology. We've built out trading platforms. We basically
have continued to improve a lot of the technology around the
infrastructure of the firm. We've continued to improve the
technology around a lot of the processes around the firm. As we
do that, we look to make sure the firm is more efficient, and
that's one of the reasons why we have pre-tax margins of 32%
for the quarter. We're continuing to be more efficient. We're
looking at ways to potentially continue to outsource some
functions that people could potentially do more efficiently
than we could do in house. I think it's just something, as part
of our culture, they're always looking to operate our existing
businesses as efficiently as possible. So it's an ongoing
activity; it's not a project. It's just something we do all the
time.
D. Goldberg: Thank you.
Coordinator: At this time I'm showing no further questions.
25
D. Goldfarb: I know everybody has a busy day today with a couple of our
competitors on at 10:00 and 11:00, so thank you for staying
with us. Again, we're very pleased with the quarter. The best
news about the quarter are not the absolute results we're
reporting today, it's the continued trend as we continue to
build our earning capacity as we go forward. We think we are
extremely well positioned to continue to take advantage of the
growth in our franchise in the coming quarters and years. Have
a very pleasant day.