Blackstone Inc (BX) 2009 Q2 法說會逐字稿

Welcome to the Blackstone Group's second quarter 2009 earnings conference call. Our speakers today arrest Steven A. Schwarzman, Chairman, CEO and Co-Founder; Tony James, President and Chief Operating Officer; Laurence Tosi, Chief Financial Officer; and Joan Solotar, Senior Manager Director, Public Markets.

I'd like to turn the call over to Joan Solotar, Senior Manager Director, Public Markets.

Thank you, operator. Good morning, everyone, and welcome to Blackstone's second quarter 2009 conference call. So as mentioned, I'm joined today by Steve Schwarzman, Tony James and Laurence Tosi. Earlier this morning, we issued our press release announcing second quarter results. That's also available on our website, www.blackstone.com, and we'll be releasing our 10-Q tomorrow.

I'd like to remind you today's call may include forward-looking statements, which are based on current expectations and assumptions, and are by their nature uncertain and outside of the firm's control. Actual results may differ materially from forward-looking statements due to several factors. For a discussion of some of the risks that could affect the firm's results, please see the risk factors section of our 10-K. All of our statements are qualified by those and other disclosures in our reports, and we don't undertake any duty to update any forward-looking statements.

On the call we will refer to non-GAAP measures, and we have those reconciliations in the press real estate.

The audiocast is copyrighted material of The Blackstone Group, and may not be duplicated, reproduced or rebroadcast without consent.

Turning to the quarter, we reported economic net income, or ENI, of $0.16 for the second quarter of 2009. That compared with a loss of $0.07 per unit in the first quarter of 2009, and ENI of $0.15 in the second quarter of last year. A notable driver of the positive ENI movement versus the first quarter was the impact of fewer negative marks on the draw-down funds, mostly in private equity and real estate, and better performance -- investment performance in both BAM and GSO. Net fee related earnings totalled $86.8 million. That was down modestly from $89.5 million in the first quarter of this year, and $90.4 million in the second quarter of 2008.

Adjusted cash flows from operations totalled $102 million, that's $0.09 per unit. That was up 37% from $75 million in the first quarter, which was $0.07 per unit, and down from $162 million or $0.15 per unit in the second quarter of 2008. We've also announced that we'll be paying the $0.30 per unit distribution related to second quarter to the public unit holders.

Before turning the call over to Laurence Tosi, just wanted to highlight a couple of items from the press release. First, we changed the name of one of our business segments, so marketable alternatives asset management, or MAAM, has been changed to credit and market alternatives, or CAMA, and that really was just to better to reflect the assets in the segment, most notably the GSO credit business. So there are no changes to which funds fall into the segment or anything related to the financials.

Second, I wanted to highlight Exhibit 2-B in our press release, which is on pages 11 and 12, gives you the reconciliation between how I think most of you look at our balance sheet with the way we're required to gross up the balance sheet for some of the consolidated funds on GAAP. And if that is confusing, or you have any questions on that or obviously anything else, you can just follow up with me or [Westin] Tucker after the call.

I'll now turn it over to Laurence.

Thank you, Joan. Good morning, everyone, and thank you for joining our call. I'll focus my comments on our financial performance and update you on our balance sheet and liquidity position.

The solid financial performance across our funds contributed to the $173 million dollars in economic net income for the quarter, driven by gains in corporate private equity and credit and marketable alternatives. Firm-wide revenues were up 7% year-over-year, and ENI is up over 9% over the same period last year, and up sharply from the loss in the first quarter of 2009.

The stable and diversified earnings base of our business was demonstrated by the fact that all four segments contributed equally, or near equally, to our fee-related revenues, and each continued to positively contribute to the firm's cash profitability, achieving $87 million in fee-related earnings, which was essentially flat sequentially and year-over-year. Year-to-date fee-related earnings are up 12%, despite the challenging markets. Cash flow followed earnings in AUM growth, and was $102 for quarter, up 37% from the first quarter this year and 13% for the year-to-date as compared to the first half of 2008. The difference between fee-related of $87 million and cash flow of $102 million is primarily driven by the gains in the -- gains the firm realized on our Treasury function, which included investment in the firm's liquid funds.

The firms fee-paying assets under management, or AUM, increased sequentially to $93.5 billion, and is up $2.5 billion or 3% year-to-date against a backdrop of cyclically high AUM declines across the industry. Blackstone has a uniquely diverse AUM mix. Approximately 50% of Blackstone's fee-paying AUM, largely on in our private equity and real estate funds, earn cash fees based on committed capital, not unrealized marks. Cash revenues in those segments are therefore insulated from unrealized marks, which affords the firm the opportunity to invest in creating value in our assets for our investors, and to patiently wait for favorable conditions to realize gains. Steve will give you some more color on the private equity and real estate funds in a minute.

The firm's remaining assets, primarily in our credit and marketable alternatives, or CAMA, segment performed well in the quarter, recognizing $2.6 billion dollars in market-driven, fee-earning AUM gains; bringing total fee-earning assets in the segment to $44.7 billion, with $23.2 billion in BAM, our funds of funds, and $20.4 billion in our credit platform, or GSO. The remaining $1 billion is in our closed-end mutual fund business. Our fund of funds, BAM, experienced one of its best quarterly returns in its 19-year history, and our credit platform has registered mid to high-teen gains in investing performance for the quarter. Collectively, the credit and marketable alternatives segment generated $22.4 million in performance fees, which are primarily recognized annually. Finally, the credit and marketable alternatives segment is up $2 billion or 5% in total assets year-to-date; a sharp contrast to the industry-wide results and market returns through the end of the second quarter.

Our financial advisory segment continued to perform well, with 24% growth in advisory fees year-to-date versus the same period in 2008, and a more than a 100% increase in our fee-related earnings for the segment, despite a significant slowdown in our fund basement -- fund placement business, as our M&A and restructuring businesses continue to gain share in this difficult environment. We continue to invest in our advisory business, adding several key hires over the last several months, as we continued to seed long-term growth in those businesses.

Our business model is such that we continue to generate solid cash flow by covering all our operating expenses, including compensation, with our steady stream of fee-related cash earnings. We also continued to be disciplined about growth in the current environment, and continue to see opportunities to hire talent and build up businesses and capabilities across the firm. This disciplined approach to growth has contributed to the firm's roughly 25% revenue and AUM compound annual growth rate over the last ten years, across many cycles. A level of our performance which, we believe, accelerates in down cycles, as we seize opportunities to gain share as market opportunities emerge and competitors are destabilized.

While we are constantly seeking new ways to continue to grow, we are always prudent with our balance sheet and liquidity, which remain at or near all-time highs for the firm. At the end of the second quarter, we had total cash balances of $785 million, our highest balance since 2007, and slightly above our cash balances for the first quarter. In addition, the firm has $433 million in our own liquid funds, and another $1.3 billion of capital invested across our less liquid funds.

Finally, the firm is seeing an unprecedented opportunity to deploy our available resources and capital to gain share and invest in profitable growth for the long term. The strength of the consistent cash profitability of the firm, through even the most difficult cycle, and the depth of our balance sheet liquidity puts us, we think, in a unique position competitively to capitalize on those opportunities.

I'll now turn it over to Steve.

Good morning. From a public markets perspective, equities, debt and commodities exhibited very strong performance in the second quarter, as you know, with July and August extending this positive performance. Strength in these markets, however, has been significantly greater than business fundamentals at this point. In a broad sense, the trends in many of our portfolio companies are similar to what we're seeing in reported second quarter earnings for public companies; challenged top line growth with significant cost cutting and low inventory levels.

With high and growing levels of unemployment, and U.S. consumers focused on improving their own balance sheets, consumer spending as starkly a driver of U.S. economic recovery has declined significantly and, unfortunately, remains under pressure. Budget deficits in the U.S. are at record level,s with the prospect of large future deficits continuing, based on current proposed legislation. We expect it will take banks at least a year or two to move past poor performing loans, and start lending again. In addition, the securitization markets are only now starting to see any signs of life. Stepping back, GDP is approximately 4% below where it was a year ago. While it could turn positive in the second half of this year, economists on average are predicting that we will not return to previous GDP levels seen at the peak until sometime in 2011.

In Europe, negative trends are still developing. We believe stabilization will lag in the U.S. -- will lag that of the U.S., excuse me. In Asia, while growth has slowed temporarily, it has reaccelerated, and equity markets in China have doubled this year while those in India are up over 60%. Despite these factors, Blackstone is currently expecting approximately 2/3 of our portfolio companies to have flat or up EBITDA this year versus last year., as compared with only 35% of the companies in the S&P expecting to have earnings improvement in 2009. Basically, we are performing two times as well as the companies in the S&P index; which is one of those things that makes private equity so special.

In part, the better market performance relates to our mix of assets, with roughly 65% falling in defensive non-cyclical sectors. In addition, our portfolio management group, led by James [Quell] is helping our companies achieve significant operational improvement across the portfolio. In one of our most recent mid-market acquisitions, Apria, a home health care company supplying oxygen, we've identified savings through efforts such as our procurement program, supply chain management and information technology. Our ability to foster change in our companies is significant, and allow us to execute better than most peers, particularly in mid-market deals, which we focus on, and where most competing firms do not have the resources and scale that we do.

CoreTrust, our group procurement platform, is quite unusual, and it buys anything from PC's to paper, overnight delivery services and office furniture. It's saving our companies $210 million each year, and that number keeps rising. We currently have 80% of our portfolio companies participating globally. Companies can stay with CoreTrust after they're no longer a part of the Blackstone family, so that the next owner receives the same benefit, and we can capitalize the savings into the sale price of the assets. Our health care version of CoreTrust, called Equity Health Care, is aimed towards aggregating demand to get better service and care for fewer dollars. It is at an earlier stage than CoreTrust, and it is expected to save our companies $50 million this year, with a goal of $140 million in savings in a couple years out.

Not unexpectedly, real estate continues to fare far worse than other asset classes, with rental rates and occupancy down in office, and similar negative trends in hotels. Office building fundamentally -- fundamentals generally lag other sectors, because of the long-term nature of the underlying leases, which roll over gradually, in the U.S. typically 10-year leases. But cash flow on those properties generally remains strong. Hotels are feeling the weight of both consumer and business pull-back in spending; and REVPAR, the standard measure that blends occupancy and room rate, continued to decline 19.5% in the second quarter in the U.S, with analysts' estimates showing moderating trends in the second half of this year, and flat to slightly down REVPAR next year, but nobody actually knows. The public market moves suggest some very positive early signs, as the hotel and lodging index rose 75% in the second quarter and 35% year-to-date, and global real estate companies issued $35 billion of equity and convertible securities this year.

The fundraising climate, except for credit products, is generally challenging; although the increase in public markets is making investors feel more confident, which is ultimately needed to move money from the sidelines. A few investor segments are investing steadily, including several sovereign wealth funds and corporate pension funds. State pension plans as a rule are under pressure, and ultimately will need a larger alternative allocation to earn their way our of increasingly underfunded position. [Halper's], for example, recently announced such an increase to alternative assets. This group is looking for a high enough return to protect the benefits for their constituents. So while over the near term we expect liquidity to remain challenged, longer-term -- and actually in the intermediate term -- we think that the allocation to alternatives will rise.

In all of our businesses, we're managing for what could be a slower than anticipated recovery, while simultaneously identifying attractive investment opportunities. We find ourselves with more dry powder than at any time in our history; currently roughly $29 billion of uninvested capital across private equity, real estate and credit. Generally speaking, debt opportunities, and buying healthy non-cyclical companies at low prices, currently provide some of the most attractive risk-adjusted rewards, though debt markets have risen since the end of 2008, and we're being selective there. GSO is greatly benefiting from scarce lending on the part of banks, and its new capital solutions fund is gaining traction.

Let me turn to some of the specifics of our business segments, beginning with private equity. Our ENI turned, as LT indicated, to a positive of $124 million compared to $31 million a year ago. The biggest driver in the improvement was the increase in performance fees, as the private equity portfolio had modest unrealized gains as compared with unrealized negative marks previously. The second quarter of 2009 we had favorable marks of 3%, which is an improvement from the first quarter when the marks were negative 3%. So we're about flat for the year. Last year's second quarter, the portfolio had a modest negative mark, a little less than 1%.

We currently have $14 billion in capital available to invest in private equity, and what we view as a particularly attractive time to invest. A number of potentially interesting investments has picked up in the U.S., while we remain more cautious in Europe. Some of the companies we are looking at include distressed assets, which have significant debt in place and where we can come in with an equity investment without the need for new debt; and others are healthy, attractively-priced middle market companies, with little debt needed, and where we can add significant value to our portfolio operations group.

We recently announced the purchase of a stake in Bank United, a coupled Florida bank. Bank united has now an experienced and talented investment team, which we helped put in place. We see a lot of opportunity to potentially acquire other bank assets in that region, and we're excited about the prospects of that investment.

While debt financing remains scarce, we continue to be a preferred client of banks, and we can still obtain funding for good companies and middle market companies generally, which is our sweet spot. We are managing our portfolio companies very conservatively, and where it makes sense we're either buying back debt or extending maturities, which is something that's happening a lot these days. To date, we have extended maturities that have brought back debt on over $10 billion of the private equity portfolio company debt. We're not expecting many dispositions over the last year -- next year or so, unless equity markets continue to improve and revenue growth is reestablished in many of our companies. We anticipate that we'll be in a position to take several of our companies potentially public in 2010, although of course this will be subject to markets at this time. However, as we mentioned in our last earnings call, we entered into an agreement to sell Stiefel Labs, and that transaction closed after the quarter on July 22nd.

In terms of real estate, ENI remained in its loss of position of $25 million, compared with negative $59 million in last year's second quarter. Worsening fundamentals pointed towards declining values, and we took negative unrealize marks of 19%, similar to the marks taken in the first quarter. The lower carrying values reflect difficult fundamentals in both office and lodging, as I mentioned, which account for a large majority of our real estate investments. Virtually all of our marks are unrealized. It's important to understand that, that these are just marks. These are not losses that have been realized, and we continue to own all of these properties.

In the lodging sector, there were nearly 20% declines in REVPAR in the second quarter as we mentioned, with luxury down even more than that. We expect leisure trends in lodging, that they'll track general consumer and discretionary spending trends, which remain negative. Corporate group business tracks corporate profitability, with a lag that was further weakened by a shift away from major corporate events.

Within office, we expect our cash flows to remain mostly stable, though vacancies will likely continue to rise. That said, market leasing activity appears to be picking up from the relatively inertia experienced through this year's first quarter, although at lower rental rates.

Real estate public debt markets like other markets have rallied sharply, including unsecured debt and CMBS. The government's TALF program is a potential catalyst to extend these positive gains and possibly loosen up the real estate lending market, which remains quite constrained. We continue to grow assets in our real estate business, closing our European real estate fund and adding assets to our real estate debt business. These additional assets under management resulted in higher base management fees of $81.5 million in the quarter from $68 million in the second quarter of 2008, which improved our fee-related earnings to $32.9 million compared to $22.8 million a year ago, which is quite unusual in the real estate business.

We're operating in a challenging environment in real estate, and remain highly disciplined in our investment approach. We have $12.4 billion dollars -- I'll repeat that, $12.4 billion -- to invest across our real estate products; larger, we believe, than any of our peers. Currently, most of the attractive opportunities we see are in real estate debt, where the risk/reward ratio remains favorable. In terms of our own portfolio, we're actively working to extend, refinance and buy back debt where appropriate. We have completed approximately $2 billion of these activities year-to-date.

Our competitive position in real estate remains quite strong. Our decision to dispose of $60 billion of assets in 2005 to 2007 -- I want to repeat that number, it's $60 billion of assets sold -- resulted in significant realizations for our investors and also delevered our portfolios. Coupled with our patience in investing new capital, we believe this will allow us to significantly outperform our peer group in the next few years. Our competitive position grows even stronger, as many of our peers are being forced to shut down or spin off their businesses for a variety of reasons. We think we will see many opportunities coming our way over the next few years in real estate.

In our credit and marketable alternatives business, CAMA, we had ENI, as LT mentioned, of $66.5 million; up from $14.4 million in the first quarter of 2009, and down from $115 million in last year's second quarter. Favorable investment performance led to higher performance fees and investment income in both GSO and BAM, which were the biggest drivers of the favorable sequential change. Fee-earning assets, as LT mentioned, are up to $44.7 million from $43.9 million at the end the first quarter.

BAM was about flat in fee-earning AUM with the first quarter, a combination of favorable performance, up 5.9% gross for the second quarter, offset by net external redemptions of $1.7 billion. BAM's redemption periods largely fall in June and December, so the outfalls tend to be seasonally concentrated in those periods. We continue to expect net inflows for the full year, based on our committed backlog, and we believe that we are far better positioned than any of our peers, who are virtually all experiencing significant outflows.

BAM's investor base is over 90% institutional, and our client service model has fostered investor stability. Approximately 50% of our investor inflows for the quarter were from existing clients, and over 90% for the six months ended June 30, 2009. BAM estimates that it is now the largest fund of hedge funds, up from a number 6 position a year ago. A recent survey listed BAM as the largest fund to funds investment advisor to global pension funds. Also sovereign wealth funds and other Government institutions comprise 18% of our investor base. This has been our fastest-growing group of investors, up from zero in 2007.

As many institutional investors were damaged by the market turmoil and publicized frauds of 2008, there has been an increased demand for BAM's investment advice and due diligence services. Many of our clients have redeemed from investment advisors that fail to uphold their commitments, and they have consolidated their investments with BAM. We have also experienced increased demand for advisory service from a number of our largest investors. These investors have asked BAM to advise on their direct hedge fund programs, as well as on their fund of fund allocations.

GSO, our credit business, is operating in an improved credit securities environment, as bond prices in both high grade and high yield recovered from lows. Fee-earning AUM moved higher, driven by favorable investment performance across products. GSO's mezzanine and new capital solutions business will benefit from the challenging borrowing climate. As you know, bank lending remains severely restricted, but the need for debt financing continues to grow, with few scale alternatives other than GSO. A general comparison in 2005 to 2007, credit markets are constrained, so spreads should be more attractive for providers of credit such as GSO. GSO's hedge fund strategy is focused on deploying cash across the many attractive investment opportunities in the liquid credit markets, including dips, distressed and event-driven situations, and selective shorts in credits that are overvalued.

The mark to market on our investments is inherently volatile, and I believe I talked to you about that in our last quarterly earnings. I did that in private equity. Now, in GSO, another example. One of the bank debt portfolios purchased by GSO last year was marked down to 35% of cost at year end 2008. But as debt markets have healed, and GSO proactively managed the portfolios, it is now marked at 110% of cost. GSO took some gains before the downturn in 2008, and then pared down select assets to deleverage and preserve the financing during the height of market volatility in the fourth quarter. As a result, the portfolio was positioned to rebound when the market recovered.

Staying power is really important in our business. Getting it carried away by looking at mark to markets in my personal view is -- is -- can lead you to a incorrect conclusion for the longer term. Neither BAM or GSO, and this is very important, was forced to suspend or gate redemptions last year, providing better liquidity to investors; coupled with better performance than peers, places them each in a very strong, competitive position. We are operating in an unusual time, during which many hedge fund to funds and credit funds find themselves in a position of weakness, having to stave large losses in their portfolio and high redemption levels. We're looking actively in CAMA at consolidating peers that find themselves in a sub-scale position.

Our advisory positions produced revenues, as LT mentioned, of $83 million, up from $72 million in the second quarter of last year and down from $91 million in the first quarter. Revenues in our restructuring and corporate advisory businesses were significantly higher than last year. However, Park Hill, our third-party distribution business, was negatively impacted by a particularly challenging fundraising environment.

While many States have increased disclosure requirements for placement agents, a reform we wholeheartedly support, the SEC has proposed a new rule this that wouldn't affect BAM placement agents from representing clients before State and municipal pension plans. We believe this proposal is an overreaction to the misbehavior of a few lobbyists, who could not be more different from the proper professional placement agent. Professional placement agents provide a valuable service to new funds, and especially small, minority and women-owned firms, by helping them access capital and to understand government pension plans through their due diligence in sourcing and evaluating potential fund management -- investments. We continue to add selectively to senior personnel in our advisory business, in sectors and regions where we believe we can have an impact. The strong Blackstone brand continues to attract top talent and clients.

In conclusion, we're operating during a period littered with many challenges. But there are challenges we've experienced and worked through in past sectors -- cycles, rather, as well as in all those sectors. We've heavily invested in our portfolio operations group globally, and believe we are adding significant value to our investments, such that when the time is right, not before, as we said in our IPO prospectus, we'll begin to exit healthier and more profitable entities at better valuations.

The economy is working its way through several headwinds, including high levels of consumer and commercial real estate charge-offs, which will negatively impact the financial system. Nevertheless, the rate of economic decline has slowed, and we anticipate a resumption of GDP within the next six months. In all of our businesses, we've positioned ourselves to be a winner by focusing on long-term value for our investors and not taking on undue risk. We leave with a balance sheet that's strong at an A rating, and fee earnings that can carry us through the most difficult cycles.

This current cycle has proven that our model works. In all of our businesses, we find ourselves in a stronger competitive position. In a period during which some fund investors are concerned about the survivability of their general partners, we are extremely stable financially, and we have not had any senior personal defections to competitors or elsewhere. We expect to see many real estate, credit and fund of -- hedge funds continue to lose share or be sold, as the environment remains challenging and some are subsidiaries of troubled entities. We will evaluate consolidation opportunities in each of these areas, as there are likely businesses that we can add real value to, to what we currently have, and where we think we can add further to its business.

At this time, we are not budgeting much in the way of realizations, but we expect to be the beneficiary of some positive surprises. As we look ahead at the value we will create from the $40 billion we have already invested in our carry funds, coupled with the $29 billion we have in dry powder, we believe that we have significant earnings power over the next several years, when market conditions are propitious for us selling assets.

Thank you for joining our call, and we look forward to answering any questions you may have.

(Operator Instructions). Your first question comes from the line of Howard Chen with Credit Suisse.

Good morning, everyone. Thanks for taking my questions. First, you mentioned in the release this morning that notwithstanding the significant rally in debt, bank lenders have not increased their appetite to make long-term capital commitments. When do you see that changing, and what are you all watching as a management team that you think would signal a change?

Well, -- this is Steve. You know, as you know from covering the financial sector, as credit losses remain really high, particularly in the consumer sector in terms of credit cards, real estate charge-offs, there will be further acceleration of charge-offs in the commercial sector of real estate, that it takes a while for the banking system to work through those kind of problems, and those problems aren't going away in the short term, and everyone has their own estimate of how long that will take.

It seems reasonable that that will certainly take at least another year to two for them to -- to really make a lot of progress through that, and until they make that kind of progress, it's -- it's very difficult for most people in the lending business to be like an optimistic extender of credit. They have to see stabilization in their business. And -- and at the moment, the securitization business is really quite muted, and you really need a high level of securitization to be able to also power up the whole credit extension environment. And so there's still a lot of repair work to be done in those areas.

Howard, as you know, the banks in this country for the last five years have not held most of their loans, they've sold about 80% of loans to different special purpose vehicles, mostly securitized but also hedge funds and other things, and basically there's no leverage available for those buyers at this point to buy bank debt. And so until -- until that comes back, the banks can originate, but their origination capacity is above their holding power, and until they can have somewhere to sell those loans on to, I don't think you're going to see a lot of appetite for originating loans.

So I think the key that we're going to be looking at is when those securitization markets normalize, and when those vehicles can raise capital, and that will be the key to really getting the bank -- the corporate credit going again in a big way. I know the Fed is looking hard at this. I know they know it's an issue, and so we're optimistic they'll come up with a plan to address it.

You've also got one other factor that hedge funds have also been buyers of these type of assets when they can get debt to leverage them and, you know, hedge fund assets as you know have shrunk dramatically from an estimated $2 trillion-plus to where between $1 trillion to $1.2 trillion. Given the performance of hedge funds, that's been pretty strong if the first and second quarter of this year, you may well see an increase in hedge fund assets, so as you look out a year or two, this would also be helpful to the credit extension business.

Thanks. That's helpful. And separately, we've heard from some other management teams maybe adjusting their expectations for distressed opportunities over the course of the cycle; they're believing that they're going to see fewer than they would have thought three to six months ago. Curious to get your views on that topic, and maybe just within distressed, where do you anticipate seeing the best opportunities?

Well, you know, I think what -- as Steve mentioned, I think the default part of the economy is still at the early stages, and what -- the problem -- the banks had a lot of problems in the last year with mark to markets, but the defaults themselves were actually not all that bad. As the defaults start to come through, you'll see companies run out of money, exhausting their covenant capacity, not being able to refinance, et cetera, and this will be true both in real estate and in corporate by the way, and so I think that those opportunities will continue to be created over the next year or two.

Now, one of the things that's happening is the banks and lenders in general, when companies or properties get in trouble are not -- are not calling -- are not accelerating their loans like they might have in years past, because there's no real point in doing that, it triggers a write-down for them, they may not be the best steward for the asset, and so on. So lot of lenders are amending terms, kicking the can down the road, and that is -- that is cutting back the number of distressed situations that hit the wall, and is definitely a factor towards the -- the lower amount of distressed opportunities than some people thought.

The other thing is the market's rallied a lot and at this point, you know, it's kind of our feeling that we're -- the low end of the credit market is probably a little ahead of itself in terms of pricing, but I'm not sure that will sustain. So I think it will ebb and flow in sort of the peak of a rally, there will be less, when the market comes down, there will be more.

I will say, however, we have a good gauge on this, which is our structuring advisory business, and that business is booming. More and more companies are hitting wall every day and needing restructuring advice. There is no end to that in sight, and I think our view is that will go on for several years. So I think it there will continue to be very interesting distressed opportunities for a long time, but I think that it's not a question of sort of buying the market wholesale in a short period of time.

Great. Thanks. Final question from me, and I can hop back in the queue. Last quarter you mentioned fundraising for alternatives was a bit spotty from traditional fundraising sources, like pension funds and insurance companies. Steve, can you speak about -- you spoke about the desire to have that increased allocation to alternatives, but if you can touch a bit on the current fundraising environment? Are LP's feeling less stressed, given the recent upturn in the markets? Thanks.

I think in the fourth quarter of last year and the first quarter of this year, this is absolutely a terrible environment for anybody in managing money. And, you know, sort of the massive declines in equities mathematically increased the amount of liquids in their portfolios, and created a situation that was very difficult for -- for many pools of capital. There was also at that time just a pervasive pessimism about the economy and it functioned to virtually immobilize almost any decision maker in terms of looking at new things.

That environment has changed. Just the way you've seen this huge rally from sort of the second week in March, you've seen all of these discussions about whether they're green shoots or some other color, and -- and you've seen a slowing down of the decline in the economy, that this has led to a change in attitudes generally. When people start making a lot of money instead of losing it, it changes their attitudes and -- and, indeed, it probably should.

So we're seeing, you know, a much more thoughtful group of potential investors. They're carefully monitoring the environment; they're sort of assessing the damage of what's happened to their portfolios, and they are starting to look at their asset allocation models and figuring out how do they repair the damage of what happened to them in the cycle, some of which will be done through equity markets, some of which will be change -- will be done by changing their asset allocation models. And there are relatively few institutions that are not thinking this through.

Particularly pension funds that have obligations to their beneficiaries, where the source of their capital for State and municipal funds involved the reliance from tax revenues, which are down, and down significantly. And so as people sit around the table at those institutions, they're looking at their asset allocation and saying how do we recover our asset base, and provide the amount of assets that are necessary to pay beneficiaries without going to State Governments or municipal Governments that are -- that are under pressure. And -- and you know, the conversations that we're having on the one hand, people who are very illiquid, you know, aren't looking at becoming more illiquid with certain alternatives, except in the hedge fund area. But as liquidity starts improving, they're basically saying we have to get to higher yielding kinds of assets to repair the damage of this down cycle.

So we think that we will be a major beneficiary in terms of our product mix of that. There's a shift to -- to more you know individual accounts as opposed to certain asset classes just being in funds, because institutional investors are looking for a little more control of their destiny in certain types of asset classes. But I would say that -- that the world has moved, you know, from just seizing up and into looking outward and evaluating alternatives of all types, but I would predict that you're going to see, you know, significant modifications in asset allocations as you look out over the next few years.

I hope that wasn't too long an answer for you?

That was very helpful color. Thank you for taking the question.

Your next question comes from the line of Mark Irizarry with Goldman Sachs.

Great, thanks. A question, actually this one might be for LT, just a little bit technical, but if you look at the carry that you reversed in real estate, you know, I thought you guys were -- or at least last quarter it looked like you didn't have any carry to reverse, you know, you had you know negative mark to market and you did reverse some carry. Could you just explain that, and then also where do you stand in terms of carry that you have yet to reverse in real estate?

Sure, Mark. Same thing we talked about on the last call. Right now with respect to real estate, there is no more carry to be reversed. There is in private equity about $317 million. I think what you're looking at on the real estate results is primarily reverse of investment income.

But remember it's fund by fund, even in private equity, so some of the funds don't actually have carry to reverse.

And also, Mark, just to point out that some of the negative relates to the individuals, and not BX itself, and so some of that is actually grossed up, so you have to think about the minority interest impact versus BX. So when you asked me before, we obviously looked at the BX number, and that's where there was no more carry, but there was carry with respect to individuals that needed to be reversed, and that has to do with the way the minority interest works out.

Okay. We can follow up offline on that one.

Steve, question for you on the LP's appetite for having their capital called. Obviously, the leverage finance markets have improved some and, you know, maybe the equity contributions and deals are a bit higher now, but from what we're hearing it seems like a lot of institutions are over-committed to private equity. You know, do you need -- do we need to see ITO's and portfolio companies taken public and distributions returned to LP's before, you know, you're comfortable calling capital from investors?

No, I don't think so. I think there have been very, very few defaults by investors, particularly if your -- your investment base are the large institutional investors, and you know, at the moment, it's -- it's an interesting overlap of the fact that as the economy is going down, private equity firms aren't calling a lot of capital because they don't want to be buying assets prematurely, at the same time that institutions aren't particularly liquid, and so they're as a rule not -- not unhappy to not get that capital call.

On the other hand, those issues will both reverse; you know, as the economy starts improving, private equity firms will start throwing down more money. Typically what happens in those types of periods is that markets tend to be going up, and so there will be pressure relieved from many of -- of the investors. So whereas this might have been sort of a bigger problem, actually, six months ago, you know when the world looked exceptionally bleak, I don't believe that this issue has as much relevance currently as it might have if the world had continued on that pretty significant downward trajectory that it was on.

Mark let me -- couple of -- chime in a couple points. The really -- the class of investor that really got significantly overlevered was the endowments and foundations, and many of them were very heavily into alternatives and got very, very illiquid. Some of them, if you add their funded and their unfunded, it is 80% of the endowment or more, a number of them. And for better or for worse, we just don't happen to have any of those in our LP mix, so we've been somewhat insulated from the pressures that they're under, first of all.

Secondly, as you probably know, we've been sort of hopefully judiciously and carefully, but steadily active throughout this period of time. For a last calendar year -- I don't know what we'll end up drawing down this year -- but last calendar year we drew down in private equity about $3.5 billion and invested that in things. Which is a healthy investment rate, and we've steadily drawn down, we're steadily funding, and we really love the deals that we're doing. So as far as we're concerned, there's -- there's -- it's an -- a very interesting time to be investing, and we've got, you know, very high return hurdles we've raised them to, because we've got sort of a surfeit of -- well, we've got a lot of interesting things to do and we want to make sure we get well rewarded for it.

Okay. Can you comment also on the fees, on the management fees for the private equity funds? Obviously there's a lot of chatter out there about LP's pushing back on fees for new funds. What are you guys seeing?

I think, you know, whenever you have a period of -- of capital shortage and adverse mark to market, you know, performance, you'll get a balance of power shift in any of these types of discussions. And I think -- I think, you know, the private equity fees for any but the smaller-sized firms are somewhere between 1% and 1.5%, and -- you know, for the large funds and, you know, there has not been significant pressure on that in the private equity area.

I think there's more pressure you know in the debt area, in terms of carries and, you know, some potential management fee pressure in that part of the business rather than on the equity side. And you know, where we've seen -- those firms seeing most of the pressures are firms where -- are funds where there have been significant problems.

Right.

They've hading to back to the LP's for -- for either rights offerings or special dispensation, amendment of the terms, and so on and so forth. In those instances, where the funds go back to the LPs and ask -- re-open things and ask for something significant, that point, naturally enough I think the LPs look for some fee concession. Fortunately, we haven't been in that situation. Our funds are healthy and -- and all of our LP's indicate to us that as long as we stay on that track, you know, they know that we've got a deal and they're perfectly happy to stick to the deal.

Okay. Just a question on the advisory business. It seems like the restructuring, that we're in sort of the sweet spot for prolonged restructuring cycle. You know, I think some of your comments on strategics, Tony, that you might see more strategic buyers interested or sort of peeking their heads out of the foxhole, can you just reconcile -- can you have sort of both of those -- you know both of those things happening at the same time? You know where you do see a lot of strategic M&A going on, yet the restructuring cycle sort of hitting its stride?

Usually those businesses are almost perfectly counter-cyclical, and didn't mean to say we were predicting a lot of strategic activity. It's coming from the deep freeze, and there are some signs of activity for the first time in a while, and it's affecting -- and some of that involves feelers to our portfolio companies. I'm not predicting an M&A boom here, that's for sure, and I am predicting an extension of restructuring boom.

I will say, though, our advisory business is a little different from the traditional M&A business; I think we'll have a record year this year, and at the same time restructuring will have a record year. So that's a new first for us, and hopefully that will continue, but I'm not making any promises on that.

Okay. Then just quickly on the margin in the advisory business, is a lot of what you're seeing there incremental hiring expenses, meaning that the margins are sort of understated there and the productivity levels are going to head higher over the next couple of quarters?

We do think this is a great time to add significant talent, particularly in the M&A business, given the problems that some of our -- the big firms are having, and the amount of extraordinary talent you can get today, and also the fact that we are building out our geographic footprint from a strong U.S. base, we're building out Europe and Asia and some other things. So we are doing investment spending.

From a margin perspective, I wouldn't use second quarter and extrapolate from there. There were a couple of one-time reserves LT can go through.

Which, Mark, I think if you look at the increase in non-compensation expenses in financial advisory year--over-year, so second quarter last year to second quarter this year, 100% of that increase was related to reserve, and that reserve reflects a delay in payment that we expect to actually get, because our -- historically our bad debt numbers are less than 1% of revenues, it's very rare, but we're required to take a reserve. So if you flattened out the non-comp expense year-over-year, what you'd see is the advisory business is up this year is up 27% in fee-related earnings the second quarter of last year to second quarter this year, and that's probably a better look at the run rate, Mark.

Okay, great. Thanks.

Your next question comes from the line of Michael Hecht with JMP Securities.

Hi. Good afternoon.

Hello.

On the dry powder you guys talked about, can you help us think about -- sounds like you guys are still relatively cautious, but the pace of capital deployment you expect in the second half and into 2010, you know, across the corporate and real estate private equity segments?

You know, Michael, it's a lumpy business and it's really hard to predict. We've got some interesting things working, but I will say it's been a -- we've gotten close to a lot of things, and then at the last minute they haven't happened, so hard to know. In our -- both businesses, or businesses where if you do a few deals in a year, that makes or breaks the investment pace for the year, so it's not a -- it's not the rule of large numbers where you can average things. But I think we're, you know, we're hopefully getting close to some very interesting deals on both sides of that aisle that should be announced in the -- in the second half of the year.

What I would say on that is that real estate will stay relatively light, because there's -- there's pressure on -- on most segments of the real estate business globally. And private equity, you know, as Tony mentioned, is -- all these things are somewhat unpredictable. But as soon as you start feeling a real bottom, which hasn't quite happened yet, really, that that you'll start accelerating your investment pace.

Okay. That's helpful. Can you give us a sense of the flow trends this quarter in the hedge fund to funds and credit funds, and the impact that redemption has had in [BAM] in particular? And sorry if I missed this, but I know you guys noted the strong quarter-to-date and year-to-date performance, and how is July performing for the fund of funds and credit funds?

First on the flows, as we mentioned, there's some seasonality in how redemptions are going to roll out. So for BAM, second quarter we had net redemptions of about $1.664 billion, but if you look at inflows as of July 1, since that's when we count the inflows, the day after the quarter, we're actually up about $400 million in net inflows so far. And the pipeline's quite strong, and I would say conservatively we think we'll be above $1 billion net inflows for the year. And as we mentioned, I don't think there's anyone else outs there, frankly, that's going to have that.

Positive performance on both BAM and GSO year-to-date second quarter and continuing through July. And I would say in both cases, looking across peers, we are outperforming on performance. In GSO, and this is kind of important, too, you know, we're raising cap solutions fund, we haven't had our close there in terms of counting the assets in fee earnings, so you don't see that yet. Same is true of separate accounts. Until you start investing those assets, they don't go into our fee earnings. So there's other assets that you'll start to see rolling through the year that we have commitments on but that we're not considering yet in fee earnings.

Okay, great. That's helpful. Thank you.

(Operator Instructions). Your next question comes if the line of Roger Freeman with Barclays Capital.

Hi, and good morning. Just want to come back to fundraising in private equity. Most industry executives seem to be indicating that you really can't raise a general private equity fund right now, but you continue to do so, albeit maybe a little bit slower. Do you think that -- I mean, do you think you're one of a small handful of firms right now that can even raise general funds as opposed to more specialized opportunity type of funds?

I think that's probably the case. I think this is a tough time to be starting out for, you know, a first-time fund. I think it would be almost impossible. For a re-up of a general fund, you know, you would probably want to wait as long as you could to get started with that, because you want the institutional investor base to become as liquid as -- as they could. So I think we -- we have some you know, sort of special advantages of a strong base and including, you know, a global brand.

One thing you find is that one -- one -- one's person's tragedy is another one's comedy. There's always somebody doing well. It may not be as many people doing well, but there's always some pools of capital that are developing and -- and you know, I think that -- that we look at this and say if a general environment is constrained, can we find places to go where we will be well-received, and you know, that's sort of part of a modern day strategy. Just waking up in the morning and saying, well, let's just go out and raise a general private equity fund, it is a difficult environment to do that without some special attributes.

You know, one thing Roger I would to add to that is there -- you know, just to fill out that pallette a little bit, the LP interest has been fairly high on distressed and related things, it's been fairly high on secondary funds. It's been lowest for the general purpose mega fund. It's been -- there continues to be interest on sector-based or regionally-based private equity funds and mid-market funds, I'd say. Our infrastructure fund's getting a good reaction.

On -- on the you know, mega fund, though, we're a little different from the other mega funds, I just want to point that out. We're sort of a very big fund, a big platform, but we've always focused on -- on sort of medium-sized deals, more the mid-market deals. We think that's sort of the sweet spot where we can bring the operating platform, the clout, the leverage with lenders, the proprietary deal flow, the things like that, that only big firms can really -- it takes scale to have, but we apply that to the less competitive mid-market, and so our positioning is a little unique there. It's a big -- it's a big mid-market fund almost, and that's serving us well in this environment and I think that's part of the explanation as to why we've been able to continue to raise capital.

Okay. That's helpful, thanks. And then, you know, across your portfolio, Tony, I think you mentioned you know two-thirds of them you expect to be at or above last year's EBITDA levels. I assume that is sort of core EBITDA? That doesn't include the gains that some of them are getting from buying back debt?

Right.

Right.

Is that still -- so how do you look at that opportunity now? I mean, we've obviously seen a lot of you know, spread compression in your higher-quality companies that I think you mentioned on the media call, sort of had that opportunity; is that sort of still there? And then the weaker ones, how do they take advantage of that? Do you infuse more capital in those companies, so they can buy back debt at a discount?

Well, look, the market run-up has limited significantly the juiciness of the buybacks, there's no two ways about it. But markets good up, markets go down. My personal view is the low end of the credit spectrum is a little ahead of itself, with the big pop it's had lately. I think that's less true at the higher end of the credit spectrum.

So that activity will ebb and flow partly based on market conditions. Whether we infuse new equity in a company or a company does not sell, buys [itself], and whether we buy the debt in through the company or -- or the fund buys it and holds it outside the company, there's a lot of permutations on that. It's all a function of the covenant structure, the availability of capital and things like that. It's less a function of the health of the company, actually.

Right. I was just thinking if you buy -- if you buy back that debt in another fund, then that debt is still outstanding, and so their coverage ratios would still be impacted by that interest expense, right?

Right. We wouldn't buy it back in another fund because of the cross fund issues, but we might -- but instead of a portfolio coming -- buying in the debt itself, the fund that owns that portfolio company might by the debt. But you're right, the point is the same, that debt is still outstanding as far as that portfolio company is concerned.

Yes, okay. And then you know, in the -- so in terms of the quarter and in private equity, you marked the portfolio up 3%, you know if you kind -- so it's like $133 million. If you sort of took the 20% on that that -- you know, that you get to something like $133 million that would have been the accrual for incentive comp, but you did $97 million, so it's 75% of the total; is that representative of sort of how much the total private equity is above cost at this point?

If we give you -- in the release, you could see private equity aggregate cost and then the carrying value. The same for real estate, so if you go towards the back of the release on -- I'll get the page --

That's fine, I'll pull it.

Page 26.

You know, it's very hard to apply those aggregates because it's top down, like you're doing, to get to the right conclusion.

Yes, I know that's tough. But I mean, conceptually there's some portion that's not -- as you mark it up, is not collective incentive. It's kind of similar to the real estate discussion before, right? So I'm just trying to get a sense for what that -- as you start to mark that portfolio back up, what the lag is going to be on [incentive] fee recognition? That's the easiest way.

Again, that's a little tricky because in some -- some of the portfolios we still have favorable fees. So, you know, you could have a situation where, frankly, you're marking up in a portfolio that doesn't, and you won't see the fee there, and you're marking down in a portfolio that does.

Right.

And you have a negative, so you actually get a positive performance [thing to] fees. Just like we had the reverse, where we had talked about the fact that we were still showing fees, even as we were marking down.

And some -- some investments that we mark it up, it instantly hits performance fees, and others there's a lag. So it just -- because it's all fund by fund.

Okay. And then just lastly, you know, I hear your comments about your views on markets maybe running a little bit of ahead of themselves in terms of fundamentals. I assume, and I've asked you think in the past, Tony, with respect to the proprietary economic indicators you get out of your portfolio companies they tend to be pretty -- I assume that's where this is coming from and just sort of curious, any sort of specifics you can give around forward indicators coming out of that?

Frankly, it's less that. You know, it's -- it's you know I think it's much as Steve was mentioning about defaults still being ahead and whatnot, and that tends to hit the lower end of the credit spectrum harder. Our look at our portfolio statistics tells us that things are -- that the rate of decline is stopping but, you know, you got a few bright spots where things are sort of actually having some quite strong positive comparisons, you still got a few negative spots where that's less - that's not happening yet. Overall, I would say it's a picture of flattening, but it's not a picture of growing.

Okay. And just as you exit, think about exiting, I mean do you take advantage of the fact that are markets are pricing in too much optimism, in terms of like some IPOs, or is it still not where you want it to be from a longer-term value perspective, and that's why you choose to wait another year or two?

We're long-term investors, and we're looking to get -- when we go into a company, we have a pretty good idea of what -- the value we can create over a multi-year period of time. If the market gives us an opportunity to realize that value earlier we'll take it, and if the market doesn't we won't, but we're not playing -- we're not trading hundred-share lots. We're not playing for a little bit of -- ahead of itself or, you know, a little pop here and a little pop there. We're trying to create a lot of value over a long period of time for our investors.

Okay. All right, thanks a lot.

That's all the questions we have for today. I'd like to turn the conference back over to Joan Solotar.

Thanks everyone for joining, and catch up with you soon.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Good day.