Blackstone Inc (BX) 2011 Q1 法說會逐字稿

Welcome to The Blackstone Group's first-quarter 2011 earnings conference call.

Our speakers today are Stephen A.

Schwarzman, Chairman, CEO and Co-founder; Tony James, President and Chief Operating Officer; Laurence Tosi, Chief Financial Officer; and Joan Solotar, Senior Managing Director, External Relations and Strategy.

And now I would like to turn the call over to Joan Solotar, Senior Managing Director, External Relations and Strategy.

Please proceed.

Great, thanks, Tawanda, and welcome to our call, first-quarter 2011.

Joined today by Steve Schwarzman, Chairman and CEO; Tony James, President and Chief Operating Officer; and Laurence Tosi, CFO.

Earlier this morning we issued a press release announcing our results which is available on our website as well and we expect to file our 10-Q in a few weeks.

I would like to remind you that today's call may include forward-looking statements, which are uncertain and outside of the firm's control.

Actual results may differ materially, and 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.

We don't undertake any duty to update forward-looking statements and we will refer to non-GAAP measures on the call.

And for reconciliations of those, you should refer to the press release.

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

So we reported economic net income or ENI of $0.51 per unit for the first quarter.

This was up from $0.32 a year ago and $0.46 in the fourth quarter of 2010.

It benefited overall from a sharp increase in performance fees in our real estate business, although performance actually was quite strong in many of the businesses, offset partially by lower advisory fees.

For the first quarter of 2011 distributable earnings totaled $197 million.

That's $0.18 per common unit.

That's up from $0.14 in the first quarter of 2010 and off slightly from the $0.20 that we reported in the fourth quarter.

So we will be paying out a $0.10 per unit distribution related to the first quarter to common unitholders and as we have outlined in the past, we intend to pay a flat distribution in the first three quarters and we will have a true-up distribution in the fourth quarter.

When LT goes through the financials and state of the different businesses and the balance sheet, he will also discuss a modification to the distribution which really reflects the tremendous growth that we are seeing.

You'll notice in this quarter's press release that we have separated our former CAMA segment into two new reporting segments, hedge fund solutions and credit.

Our hedge fund solutions/credit is primarily composed of our BAAM customized solutions business but it also has the Asian advisory funds in there as well.

As always if you have any questions on anything in the press release, you can follow up with either me or Weston Tucker after the call.

And with that, I will turn it over to Steve Schwarzman.

Good morning and thanks for joining our call.

The first quarter, the global economic recovery progressed and broad global equity and credit indices moved higher, although performance varied significantly by region.

Equity indices in developed markets generally outperformed those in emerging markets.

In the US, markets are currently within 1% of their highest level in the past three years.

A combination of positive economic data, a strong fourth-quarter earnings season and another round of government stimulus has helped to sustain positive investor sentiment.

So far this year, we have seen substantial money flows into domestic equity funds which have helped support the markets' move higher.

However, investors have had to navigate an increasingly volatile and uncertain geopolitical and macroeconomic backdrop.

An accumulation of factors drove a rush to liquidity in mid-March and temporarily unsettled markets everywhere.

These factors included escalating fears of inflationary overheating throughout the emerging markets, further deterioration of the eurozone sovereign debt situation, large-spread political turmoil throughout the Middle East and North Africa and the devastating earthquake and tsunami in Japan.

There are also increasing indications that more central banks will engage in rate normalization to combat inflationary pressures.

In the US, we anticipate a longer economic recovery cycle at the bottom hampered by persistent unemployment, higher commodity prices and negative impacts of housing and the US budget situation.

We expect growth will continue to improve.

We believe the economic expansion will become increasingly self-sustaining.

The significant change in the government rhetoric towards the business community has also made a noticeable difference in our outlook.

Blackstone's first-quarter results further demonstrated our ability to generate outstanding returns for our investors and attract new capital.

Although it's early in the cyclical recovery, we reported our best quarterly earnings since becoming a public company almost four years ago.

Continued inflows into our funds and rising asset values drove our total assets under management to a record $150 billion, up 43% from the same period last year.

Just to repeat, we are at a record AUM of $150 billion, up $0.43 from this same period last year.

Two of our global real estate funds BREP V and BREP VI, that's Blackstone Real Estate Partners V and Blackstone Real Estate Partners VI, moved above the preferred return hurdle and into their catch-up period and accrued substantial performance fees.

We opened the investment period for our latest private equity fund Blackstone Capital Partners VI on January 7 which is now earning full management fees.

We have $32 billion in dry powder across the firm to put to work over the next several years.

In private equity our portfolio companies continued to perform well with approximately 85% reporting growth in revenue or EBITDA.

Earnings projections improved, helping drive portfolio appreciation 5% in the first quarter.

Our BCP IV fund which is earning full carry recorded the greatest level of appreciation.

In general our portfolio company management teams have improved their outlook on general market conditions and the expected rate of economic growth.

In terms of new investments, we committed $550 million in the first quarter with a continued focus on the energy sector.

We invested in an oil and gas corporate partnership with Geosouthern Energy, a private energy company based in Texas.

We also completed the acquisition of a third refinery with portfolio company PBF Energy Partners, our platform for consolidating refinery and the associated terminal and pipeline assets.

And last week, we announced we would commit up to $1 billion over time to acquire and develop unconventional oil and gas assets in North America in partnership with an experienced management team in the space that we know very well.

The financing environment for new deals and refinancing remains very favorable, although the price per transactions is somewhat higher than we expected at this stage in the economic recovery.

LIBOR and treasuries have remained at historic lows and spreads have tightened towards historical mid-cycle norms.

We believe LBO transactions requiring $5 billion to $10 billion of financing can be executed on attractive terms.

We will also pursue opportunities to further improve the capital structures of our existing portfolio of companies.

Since the beginning of 2009, we have undertaken capital market transactions in which we reduced, refinanced or extended over $66 billion of portfolio company debt which equaled to over 60% of our Company's combined indebtedness.

We had $1.7 billion of total investment realizations during the first quarter which was our highest quarter in several years at a multiple of original invested capital of 1.9 times cost.

Realizations for the quarter included a dividend from a portfolio company, Vanguard, our successful IPO of BankUnited as well as a follow-on offering of TeamHealth shares which occurred at over $17 per share versus our offering price of $12 per share in late 2009.

We expect more realizations as our portfolio companies mature.

On average, typical realizations are valued at approximately 20% over the prior quarter valuation.

Moving onto real estate.

The value of our real estate portfolio further appreciated in the first quarter with a combined increase of 9%.

We recorded sharp increases in value across all of our sectors including office and hospitality which comprised the majority of our exposure.

While this is partly the result of the broadening recovery underway in commercial real estate, more importantly, it is the result of our best in class assets, solid management and patient long-term capital structures.

There have been no material realized losses to date in any of our funds.

I will repeat that.

There have been no material realized losses to date in any of our funds which is in sharp contrast to nearly all other investors in the developed world in this asset class.

Many of our large competitors have downsized or exited the business and Blackstone remains as the preeminent buyer of size with the largest pool of discretionary capital.

We remained extremely active in terms of new investments in real estate, committing $2.8 billion in the first quarter.

We've invested or committed over $8 billion since the fourth quarter of 2009 when we started to see early signs of market stabilization at low prices relative to historic values and replacement costs.

In virtually all recent transactions, Blackstone has faced limited competition due to the magnitude of capital required and the complexity of the transactions.

Our primary focus has been on bankruptcies, recapitalizations and debt acquisitions.

Examples include investments in Sunwest's financial, senior living, extended-stay properties and general growth properties out of bankruptcy as well as our recent agreement which has been well publicized to purchase Centro's US assets.

In the Centro transaction which is still pending, we are acquiring 593 grocery-anchored neighborhood shopping centers in 39 US states.

This $9.4 billion transaction, the largest cash purchase of real estate in the world since the Lehman Brothers collapse, is another example of our unique position in the real estate space.

Our ability to deliver certainty to the seller in the context of a multi-party restructuring was a tremendous competitive advantage.

Our debt strategies business which provides mezzanine lending to the recovering real estate industry is approaching $4 billion in size and we have grown that organically from zero over the past three years.

We have been generating very favorable risk-adjusted returns for our investors and the debt hedge funds returned 5% gross in the quarter.

The opportunities in real estate are vast.

Despite recent increases in real estate public and private values, we believe that a mass of overleveraged properties in loans from years leading up to the financial crisis will need to be restructured, recapitalized or refinanced over the coming years.

Providing substantial opportunities for our real estate business.

We have commenced fund raising for our most recent flagship real estate fund which is expected to have its initial close later this year.

We see no reason why this fund shouldn't be comparably sized to BREP VI.

Moving on to BAAM, which designs custom solutions for large institutional clients using hedge funds, BAAM is now the largest manager in the world in the hedge fund to fund space and continued to take share in the first quarter including April subscriptions.

BAAM had fee earning net inflows of $3.1 billion, roughly equal to the whole of 2010.

Approximately half of this was raised in BAAM's long-only equity replacement product.

Early in the quarter we also had the final close of our second hedge fund manager seeding platform called Strategic Alliance II at a total fund size of $2.4 billion.

These assets will earn fees as the capital is drawn over time.

During the first quarter, we invested roughly $200 million of this amount in two very promising managers, one in commodities and and the other in a long-short equity strategy.

BAAM generated a gross composite return of 1.9% for the quarter with substantially less volatility than the market and most other asset classes.

As of April 1, our substantial inflows and positive performance resulted in total assets under management of $39 billion which is a record for us.

Our credit for platform GSO remains one of our fastest growing businesses as we have been very successful in identifying dislocations in the market and then building vehicles to deploy capital towards those opportunities.

In our customized credit strategies which includes our long-only platform for investing in leveraged loans and other credit products, we continued to expand and diversify our product offering.

We are seeing inflows into separately managed accounts and co-mingled funds as the senior loan asset class benefits from the strong appetite for shorter duration income generating products and we continue to generate excellent risk-adjusted returns.

We've also filed with the SEC to launch our third closed-end fund focused on floating-rate instruments.

With the potential for higher interest rates and rising inflation on the horizon, we expect this asset class to perform well.

Our $3.3 billion rescue financing fund which had a final close last summer is now over 35% vested with a strong backlog of opportunities.

We already had two small realizations in this fund in the first quarter and expect two additional realizations in the current quarter.

All investments in this fund are valued at or above cost with the fund as a whole valued at 1.3 times the original cost.

The fund also benefits from several positions that include an equity tranche and these positions have performed well and we believe have meaningful upside potential.

Our flagship mezzanine fund has achieved a 22% gross IRR since the end of the first quarter, driven by strong underlying portfolio company operating performance.

We are seeing good traction raising our second fund and expect to announce an initial closing in a few weeks.

Our focus remains on mid-market borrowers which have had limited access to the bond market, so there remains a great opportunity to provide good companies with much-needed capital on favorable terms.

Our credit oriented hedge fund performed very well in the first quarter and we're up 8% gross, outperforming the relevant benchmarks.

We are optimistic about the risk-adjusted returns that our event-driven investment style can generate in the current environment.

A final note on credit.

The US CLO market is beginning to recover and there are several CLOs in the process of being raised in the market reflecting rising confidence.

We continued our efforts to consolidates this industry announcing the acquisition of the management contracts related to four European CLOs from Allied Irish Bank totaling EUR1.5 billion.

Pro forma for this acquisition, we will manage over $18 billion in CLOs globally making us one of the largest managers of this type of specialized investment vehicle in the world.

In our advisory segment which is composed of three businesses, as you know -- M&A, restructuring and our Park Hill fund raising business -- revenues declined from record levels in 2010 to $73 million in the first quarter.

Our M&A business saw revenues decline year over year although our backlog is up as revenues are highly dependent on the timing of when deals just happen to close.

The outlook for M&A activity generally is very strong, as you know, and we should benefit from greater global activity expected in 2011.

In restructuring, revenues declined versus the same period last year as expected.

The strong high yield market and the improving economy are contributing to a slower restructuring market and many companies have been able to refinance rather than restructure.

Finally at Park Hill, activity has returned to more normalized levels as markets have healed and revenues were up 150% over a year ago.

In summary, as the economic recovery progresses, the world continues to improve.

Blackstone is further well positioned across all of its businesses to identify new opportunities, strategically deploy capital and generate outstanding returns for our investors.

Our array of businesses is unique and each is a market leader with a proven track record.

This doesn't happen overnight.

Our collection of leading franchises and the way in which they function together to make the whole of Blackstone better more than its individual parts is what I believe makes us truly exceptional in the world of investment managers.

With that, I'd like to turn the call over to Laurence Tosi who we affectionately call LT and we will close with some comments on our financial results.

Thanks, Steve.

The last year has followed Blackstone's pattern of strong growth following periods of market disruption as investors focus on our outperformance across cycles.

Fee earning AUM rose 26% year over year to a record $124 billion and as Steve pointed out, our total assets grew 43% to a record $150 billion.

The sequential growth in fee earning AUM was driven by gross fee earning inflows of just under $18 billion which includes the launch of BCP VI in the first quarter as well as strong inflows across BAAM, GSO and our real estate debt business.

Inflows in performance helped generate economic net income of $568 million after taxes, up 58% year over year.

The growth in ENI was driven primarily by our best quarter for performance fees since early 2007 which totaled $601 million, more than triple the levels of the prior year's first quarter.

We were also able to take advantage of solid markets to begin realizing performance fees as we found opportunities to successfully liquidate positions which in turn drove the $96 million of realized performance fees in the quarter.

Distributable earnings were $197 million, up 32% year over year or approximately $0.18 per common unit, well in excess of our quarterly distribution of $0.10 per common unit.

A few observations about the segments.

Our private equity segment generated performance fees of $115 million of which $82 million were realized as our BCP IV fund continued to perform well.

This fund is fully in carry and has a current carrying value of $6 billion for a 40% net IRR and a 2.6 times multiple of invested capital.

Fee revenues for the segment also increased due to higher AUM and an increase in transaction activity.

Our real estate segment reported performance fees of $371 million.

Our two largest global funds representing over $16 billion in fee paying capital exceeded the return hurdles in the quarter and moved into their catch-up period, whereby the firm is entitled to 80% of the gains until we reach 20% of the total gains for the fund.

These funds heavily contributed to the segment's performance fees and were approximately 60% of the way through the catch-up by the end of the first quarter.

This is the first quarter that we break out our hedge fund solutions or BAAM and credit businesses into separate segments.

There are a few fundamental businesses between these businesses and private equity real estate that you should keep in mind while evaluating the results.

In our hedge fund solutions segment which is primarily BAAM but also includes our Asia advisory businesses, revenues grew 18% year over year and ENI rose 10%.

The segment generates management fees largely on its fund's net asset value.

This equates to fee paying AUM which grew to a record $36 billion up 24% year over year.

First-quarter numbers exclude 1 billion of additional subscriptions or inflows which we received on April 1.

It also excludes $2.1 billion in capital from BAAM's seeding platform which has yet not been drawn and is not earning fees yet.

About 50% of the segment's total assets or $18 billion are performance fee eligible and 74% of those assets or $13.5 billion were above the relevant benchmark which drove performance fees of $20 million for the quarter.

Our credit platform also had a very strong start to the year.

ENI of $60 million grew 45% from the same period last year as management and performance fees both rose sharply.

Fee earning AUM for the credit segment grew year over year by 28% to $26 billion as we raised new funds and deployed capital.

At the end of the quarter, the credit segment had approximately $4 billion of committed capital that was not yet paying fees because it was not yet deployed.

When looking at the financial results for the credit segment, you should keep in mind that ENI and fee earnings reflect a charge for minority interest of approximately 15% of the Company that is still owned by the former GSO equity holders.

This remaining interest is reflected in expense and margins and is paid as a profits interest which we have a contractual arrangement to purchase over the next several years.

Lastly our advisory segment declined year over year with declines in our M&A business and restructuring partly offset by very strong growth in our fund placement business.

As GAAP requires accrual for compensation for these businesses on a full-year basis which impacts first quarter profitability, as has been the case for the last two years, the fourth quarter tends to be stronger for deal closings across all three businesses in our advisory segment and tends to leave a weaker first quarter as revenue pipelines for the deals rebuild.

Finally a few thoughts on balance sheet and liquidity at the end of the quarter with treasury and cash and liquid investments of $1.7 billion which is roughly flat year over year.

With more than 70% growth in fee paying assets and commitments since the downturn, the last few years have further demonstrated that Blackstone's business model accelerates in periods following a dislocation and places us in a unique position to further invest in our capabilities and to launch new businesses and strategic initiatives.

Blackstone has successfully launched scale new businesses since the downturn including our real estate debt platform, GSO's mezzanine and rescue financing funds and several international funds.

Strategic deals executed during this period include the acquisition of GSO and our recent investment in Patria.

All of these initiatives contributed meaningfully to our growth.

To continue to capitalize on this trend, we're taking several measures to enhance our capital position to help fuel our continued growth.

We will begin retaining gains on Blackstone's principal investments while continuing to pay out all other earnings including performance fees and management fees.

Retaining investment gains will provide the firm with a permanent and growing capital base upon which to continue our disciplined investment in growth.

We will retain the full-year gains on our investments from our fourth-quarter distribution payable in the first quarter of 2012.

Principal gains are of course unpredictable in their amount and timing.

Historically however, our principal gains have comprised approximately 6 to 10% of annual distributable earnings.

Additionally, we have modified our current $1 billion revolver for an additional five-year period expiring in April 2016 at a lower cost.

These strategic moves to further solidify our capital position reflect our continued confidence in our ability to manage capital to gain market share and outperform across all cycles.

On behalf of everyone here at Blackstone, we thank you for your time and joining the call and we welcome any questions that you may have.

(Operator Instructions) Roger Freeman, Barclays Capital.

Hi, good morning.

So actually, let me just start with that last point about the investment gain sort of being held back from the distribution.

So I understand the point about that building up capital to invest alongside for future deals.

But I guess the -- you did a bond deal not long ago that was I thought kind of supposed to support you through your commitments on BCP VI.

Trying to think about whether you really have a call for additional capital near-term to fund [alongside] deals.

I don't think you should look at it as just something that we're doing to fund our commitments because as you know, our commitments are over a very long period of time and actually right now, they're just over $850 million which most of it, half of it is not due until it has investment periods of more than three years.

We're looking across organic growth opportunities, seeding new funds, those commitments as well as strategic alternatives.

So it's a combination of all those that we feel like we're bullish on the prospects for growth and it's the right time to retain capital.

Also the fact that we can then create a renewable fund if you will from which to base that growth is important to us.

We also like to keep a lot of liquidity in the Company and not rely on borrowings.

We think a strong balance sheet is is a strategic weapon.

Sure, okay.

So actually if you think about it in the context of -- I don't know if I'd call it -- if you specified how much of the fee earnings -- is the goal 100% there?

Because the difference is on your investment gains, whatever, 6 to 10%, then if we had already assumed that you'd only pay out 80% of your distributable earnings, that doesn't really change here.

In fact (multiple speakers)

So Roger, let me just break it down to make it very clear.

So when I said 6 to 10%, it's 6 to 10% of all distributable earnings.

So for example, last year we had $700 million in distributable earnings.

We would've retained about $48 million or roughly 6.2%.

Another way to think about it, I think the simplest way is really we committed over time anywhere between 2 and 5% of the firm's capital in funds.

As we have realizations, we get that initial capital back.

But as you grow the firm and you have the opportunity to create new products, you can take the gains on that principal and use that to seed the new products.

So it's almost like creating an evergreen fund within the firm itself.

Exactly, well it's also consistent with how competitors seem to be doing it.

Yes.

Okay, now I guess I want to ask a question on private equity.

Last year first quarter you had a big markup relative to what markets did.

And as I recall, there was some sort of impact of raising your earnings expectations for your portfolio companies following I guess getting year-end financials and kind of assessing the growth outlook.

Is it fair to say that I guess given your sort of macro comments here that the growth expectations haven't really changed a whole lot?

In other words, there's no step-up this year because you have sort of a higher growth outlooks for your portfolio companies.

It's always company by company, but I would say generally speaking, we haven't accelerated growth beyond what we were thinking in terms of planned for this year.

Certain segments are growing faster but I would say generally speaking, we did not really change the assumptions.

But there's movement within the portfolio, obviously some up, some down.

Got it.

Okay, and then maybe one more and I'll jump back in.

Of the other realizations in the quarter on private equity, I think you mentioned a 1.9 times multiple on invested capital.

In the context of your sort of historical MOIC, that's a bit on the low side.

Do we read anything into any pressure [of this incremental piece] to realize -- to get realizations to return cash or is this just a function of the mix of what you sold in the quarter?

It's just a function of mix and we did a bunch of IPOs, and a lot of times what we do when we IPO is we don't sell many shares and we come out at what we consider to be an attractive price for the public and expect that to appreciate thereafter.

Just like on the TeamHealth where we took it public at 12 and then started selling some at 17, it was a good ride for the investor.

We put money in the company and that was our real (multiple speakers)

And same with Graham which we took public.

I don't even remember what we took it public at, 10 or something, and we just agreed to sell it at 19.

So it's part of a process.

And actually that just brings up one other point is when you do an IPO, is the market appetite right now such that you can sell on the IPOs?

Where do you think we are on that sort of tide that typically you're going to have to wait for secondary or are you going to be able to sell more on the IPO?

Usually we can sell on the IPO.

Very often we don't sell much because we actually think the value is too low at that time and we let the company season, we let the company demonstrate its quality and the earnings progression and momentum that it has and at that point, hopefully the valuation will be higher.

Howard Chen, Credit Suisse.

On the pace of the deployment, we saw a pickup on the private equity side, real estate step back from a really big end to the year.

Just would love to get your broad thoughts on the pacing as you see it from here, the environment for deployment.

Well, we think it's -- we are in a business that is lumpy, so you do one Centro and it moves the whole quarter around.

We think generally speaking that the -- we will be steadily putting money to work in private equity although they won't be huge probably headline kind of deals for the reasons that I mentioned or Steve mentioned.

And then in real estate, I think there's a lot still to do.

And, Howard, I think you're looking at closed versus committed.

So Centro was actually announced in the first quarter, so I wouldn't say there has been a step back in opportunity.

Great, thanks.

And then I know this is very market dependent as well but just on realizations, your broad thoughts on the pipeline and maybe contrast that a bit between the traditional private equity side and real estate?

Say that again, Howard?

Just thoughts on the realization pipeline.

Well, okay, so, the realization pipeline, we've talked publicly about private equity and a number of IPOs over the last couple of years I think, and that continues to be pretty steady.

I think if you look at our activities for the last couple of years, we've distributed slightly more money quarter by quarter than we have invested actually.

So we've had a steady pretty good robust stream of distributions to our LPs at multiples two to three times their money.

We see that continuing.

So as I think I mentioned, we have had recent filings for Vanguard and Kosmos and there will be others coming and other things going on.

With respect to real estate, we haven't had much in the way of realizations because it wasn't frankly a very good time to realize.

But what's happening now is the combination of the momentum we see at the property level, the low cap rates driven by frankly low interest rates, frankly an awful lot of investor appetite for hard assets with an embedded inflation hedge, and I think as some of that operating momentum gets translated into cash flows, it could be a pretty propitious time to start to realize on some of our assets we've got some really great embedded values.

So I think that's coming in a much greater degree than you have seen in a recent past.

Great, thanks for that color.

And just finally for me, a follow-up on the capital retention.

Where do you see strategic acquisitions fitting in and what is the environment like for those?

We still have the Volcker Rule on the horizon and we have the announcement this week that B of A is spinning off one of their businesses.

So we would just love an update on how you see the acquisition environment.

We regularly look at opportunities that we think might make some sense and we have been nibbling around the edges if you will with some fill-out of the CLO business.

We get approached on a regular basis as you might imagine all the time by people who want to combine with us because the firm has an extremely strong brand name on a global basis.

And the type of growth we've had in terms of starting new products and product lines is quite unusual in terms of the financial world, in terms of being able to expand through really difficult times.

So we're always open to look at things, but we are very cautious.

We sort of zealously guard our culture.

Besides financial criteria, you know you have to fit with a place like this which is a little idiosyncratic.

We're like really exceptionally hard-working people and we do our best to run a [zero defect] culture.

And we have high levels of enthusiasm and real self-starting, exceptionally capable and bright people.

And so there are many things that we can buy.

But part of developing a firm and developing it well isn't just buying things to be bigger.

I don't think bigger is as important as better.

So we're very cautious in what we look at but we want to be prepared if there is something that is a terrific fit and works well.

I mean, Howard, we look at a steady steam stream of things and as Steve says, we keep the bar high.

But we have not been inactive.

Over the years we have bought GSO, we've made a major investment in Brazilian affiliate Patria, we have done two CLOs and we bought the Asian real estate business of Merrill Lynch and also the Japanese NPL business in Morgan Stanley.

So we have been pretty active.

Great, that makes a lot of sense.

Thanks, Steve; thanks, Tony.

Dan Fannon, Jefferies.

Can you just talk about the competitive framework for investing capital?

There appears to be a lot of -- including you coming out later this year with fundraising within real estate, so demand from an investment side appears to be picking up.

Can you just talk about what that means for you and what the competitive framework is potentially meaning for pricing?

In real estate?

In private equity as well.

Okay, so, in private equity, you know there was a whole lot of capital uninvested when the meltdown happened that didn't get invested, about $0.5 trillion is the number that people throw around.

If you divide that by segments of the market, an awful lot that was in the megafunds and the amount of uninvested megafund capital has started to come down as people put more money to work than they have raised, and I think that will continue.

So I think fundamentally the supply of capital on the large end will improve in terms of supply/demand balance.

But right now there's still a lot of uninvested capital.

So big plain vanilla deals that get auctioned are pretty pricey because you've also got of course the strong credit markets.

As I said in the press call, we are still finding plenty of interesting things to do but we're doing them in emerging markets, in growth capital, in consolidations and buildups and a bunch of energy things.

So that's a picture of private equity.

In real estate you had some of the same factors, the low interest rates have made that a plain vanilla fully optimized building to sell as a one asset has a lot of people eager to buy it and there's a lot of people particularly in international pools of capital that want to come and own that kind of building in prime core markets like New York or Washington.

You get outside of that, you get more peripheral markets or you get buildings with operating issues and so on and so forth, demand -- that's much more specialty and we've been doing some interesting things there.

But most particularly, we've been focused on the huge amount of troubled real estate financing that's left over from the bubble period.

There's still a lot of owners that are distressed, there's a lot of capital structures that can't roll over and that has been great for our guys and we have I think a long way to go on that before we work through that.

Are you talking about LPs or their attitudes or what Tony was focused on which was the investment opportunity set?

I was just focused on what Tony said, but I certainly can take it from the investor perspective, the LP side, if you have a comment there.

On the LP side, I think we are finding that in private equity and across the board, LPs are reassessing their number of relationships and how much capital they want to concentrate on which managers.

It's no longer an across the board successful re-up.

Every time somebody finishes an old fund and goes to market, there's much more discrimination.

I think that there is much more of an emphasis on a safe pair of hands that has gotten through the crisis well as well as can communicate well to LPs and their Board of Directors.

And there will continue to be a flow of capital but it will move more selectively and I think the LPs are waiting generally for more distributions although those are coming.

On real estate, it has been a very shocking experience because real estate values from the top depend on what part of the world you are talking about, went down as much as 40%, commercial real estate, not talking about residential.

And that created really almost a trauma.

In the opportunity class in particular, it performed quite badly.

Most managers will end up in a loss position in many cases of significance, and so the number of players left in that sector are exceptionally small.

And so I think that sector itself was up for reassessment.

And you know, we are fortunate in that line of business to have been sort of an extremely strong protector of capital, and in all probability, very successful with every fund we've ever done in that asset class.

But I think there is concern on the part of LPs as they look at what happened in the asset class, realizing that it takes something special to actually be good.

Just buying a market is not enough.

Just announcing you want to be in an asset class is not enough.

I think there is suspicion in that regard which fortunately we don't particularly get lumped into that bucket.

But I think the LPs are basically finding their footing again.

Their portfolios have performed well, the alternative classes as a group absent what I just mentioned about the limited category of opportunistic real estate have outperformed most of their other asset classes.

And so I think we've been through a very interesting cycle where the alternative asset classes come out as big winners within most LPs asset allocations and over time will be getting as we said earlier more and more money.

That money we expect will be much more concentrated and from our perspective, that process works for us.

LPs are now looking much more seriously at firms with multiple asset classes and expertise which also is something that works well for us given our array of products in the alternative class which is more than anybody else's.

Great, that's helpful.

I guess one follow-up is on the hedge fund solution business, now that you guys are at kind of record levels, are there any capacity constraints within that segment?

No, it's interesting, we just had our -- we do our strategic reviews in April and a little bit early May.

We just did the BAAM strategic review yesterday, so we're -- everybody on this phone call is like we're full up with BAAM in terms of what is up to date.

And they're not experiencing those types of issues.

It is a much more complex business than just simply rolling out one large fund of funds and stuffing everyone you can meet into it.

We have many different types of strategies, different types of managers in those different types of strategies, large limited partners.

We're not -- unlike most people -- we don't have really any retail focus in this business.

And almost everything we do whether it's now a separate account or some other grouping of hedge funds to solve a particular problem is designed with a large account in mind.

It's really a hedge fund usage to solve problems, and there are a lot of different managers.

There are structural changes where as the Volcker Rule impacts the large investment firms, there's almost like a record number of really capable people setting up business, more than we have seen which provides more and more high-quality talent.

That sector, the hedge fund sector, is being impacted by those type of regulations in a way that benefits a firm like ourselves.

Dan, let me just add to that.

Less than half of the capital in the custom solutions business as we call it is actually in fund to funds where you might have capacity issues.

The rest are in things like drawdown funds which are seeding new managers, they're in long-only funds that we offer again to solve investors' particular goals which are sort of unlimited capacity.

And they are in the actually truly customized solutions where we put something together again for a particular investor that's individual, and it's sort of like -- since it's not -- it doesn't come on top of anything else exactly the same, it's sort of again -- it's sort of -- there's unlimited capacity to do that.

So no, we are a long way from testing the limits of scale there.

Yes, I think that business has been growing in the 20 to 25% area, and I think we are comfortable based on our plans that we will be able to continue to grow that business at those kinds of levels with superior performance, not straining the model of that business.

Bill Katz, Citigroup.

Thank you and good morning, everyone.

Just a couple questions.

The big one is I guess just in terms of when you talk about the LPs in terms of consolidated mandates, can you talk a little bit about any kind of shift you are seeing in the economics of these mandates whether it be higher percentage of the transactions or higher percentage of the management fee if at all?

Sure, there is a sort of a sense of particularly with the largest LPs wanting to quote get a better deal.

I think that comes with the territory of life.

There is a greater demand for co-investment opportunities.

Most next-generation of private equity funds will be smaller than the ones raised right at the top because there is less money in the financial system, not because the asset class is damaged.

But just if you have less money, you just don't invest the same amount.

And so those are issues that lead to more sort of discount if you will on a management fee for very, very large commitment.

I think that there's not that kind of pressure particularly on carried interest percentages.

Those look like they are sort of settled into where they are pretty much, and we are seeing that probably in real estate.

Our GSO business, geez, it is so busy there.

There's so many products and so many LPs that that is a rapidly expanding asset class as people are almost desperate to get yield in a world where almost every central bank until quite recently was just dedicated to the lowest interest rates they could create.

And because we are creating high levels of interests yields, that business has been holding up quite well.

In terms of sort of the compensation structure and credit, it's just a little bit reversed sometime where uncertain of their drawdown funds, it's really just in the credit area of course, for the most part that management fees get triggered when money is invested in real estate and private equity as it has always been traditionally where you have to pay your staff, so you need your management fee.

So I think there is a little bit of pressure which comes from a world where people really got adversely affected across their whole investment structure, not just what we do.

And so there is a little response, but it's something that buyers and sellers work out.

So that's the way I would look at that.

Okay, thank you.

Second question, this may be just in terms of the impact of the recent fundraisers, but can you talk a little bit about the dynamics quarter to quarter with the decline in fee related earnings?

Sure, Bill, it's LT.

I'll touch on that.

In the first quarter, if you look at it, our compensation ratios by and large across the firm were relatively steady on a year-over-year basis.

They tend to be slightly higher in the first quarter than in the fourth quarter, and that is because you try to accrue over the course of a full year and the fourth quarter tends to be a little bit busier on a transaction side.

So you see us at a 52, 52.5% comp ratio in the first quarter which is relatively typical.

What's not typical were the non-compensation expenses in the first quarter.

And the reason for that was really related to we've had a lot of fundraising activity, so if you look at the growth in non-compensation expenses which is putting pressure on the net fee related earnings, it's about $30 million on a year-over-year basis.

That $30 million, half of it's related to business development and fundraising which is non-recurring expenses related to those activities.

About a quarter of it is related to the new bond deal in September and the rest of it is just normalized growth activities.

So actually we're gaining leverage out of our non-compensation expenses ex fundraising and financing expenses.

So hopefully that's helpful.

Very helpful, thank you.

And just last one very technical.

I didn't see it and maybe I just missed it reading through so quickly.

But did you put in your release the unrealized carry at the end of the quarter?

You know, we didn't.

We typically put that number in our 10-Q which will come out on May 6, but I can give you the number if you want.

When you see the Q on May 6, you'll see a cash and investment line on our balance sheet which is footnote 4 of about $5.2 billion.

Within that number is $1.65 billion of accrued performance fees.

Remember, Bill, when we use the word performance fee, we include both carry and incentive fees.

So it's about $1.65 billion.

Okay, thank you very much.

Patrick Davitt, Bank of America Merrill Lynch.

You mentioned a few items that are committed but not yet in fee earning assets like the Allied Irish CLO, the dry powder in credit.

Can you kind of give a rundown of everything that's like that that you have the money as of the end of the quarter but it's not earning fees yet?

Sure, so, Patrick, the total number for the firm right now, what I would call capital committed but not yet paying fees is $11 billion.

I'm not including Allied Irish in that because that deal hasn't closed yet.

If you break it down by segment, it's $3 billion in BAAM, it's $4 billion in credit, it's $2 billion in real estate and it's $2 billion in private equity.

And let me explain the last two for a second.

The $2 billion in real estate is really concentrated around our real estate debt strategies business which doesn't begin paying fees util the capital is deployed which is also the way as Steve pointed out several of the GSO funds work.

In private equity what that is is with the close of BCP V, the remaining, the reserve if you will of about $2 billion, will stop paying fees but it's committed and fee paying should be deployed.

So that could last for a very long time.

For example, we put money to work in BCP IV this quarter as a follow-on to some investments.

That then was added to fee paying assets.

So the total number is $11 billion.

Okay, great.

And the credit business, you mentioned that you're just starting to raise kind of a second generation of funds.

Could you give me an idea of how many strategies are getting into that second generation and ultimately I do get the feeling that the size of that second generation of commitments could be equivalent to the first generation?

Well, we think the size will be bigger generally, but it will vary some by business.

We've got -- and just to remember what is in our credit business, we've got a distressed credit business.

That's not fund raising right now.

We've got a mezzanine credit business that is fund raising right now which we expect to be bigger than the last generation, if you will.

We've got a hedge fund business which is always open but -- and has put up some very good numbers but hasn't really been very focused on fund raising lately and with what's going on with the money [and we'll come back] in the hedge funds, we think that will start picking up again.

We have a whole lot of separate accounts that are almost where investors want cash yield and the ability to get their money back out.

Some of them are cash management programs for corporations, some of them are for pension funds, some of them are for wealth funds.

There's a whole lot of variation on that, some want high yield, some want floating-rate, some want fixed rate.

And that continues to go on.

I would say there's probably a somewhat softer appetite in that now as interest rates have gotten so low.

But the money is still there earning its keep, so to speak.

In CLOs which is a very big business for us which is where the Allied Irish would be added, the securitization market is opening up again.

We have done a new CLO, expect to do others after it being closed or essentially closed for three or four years.

So we think that will be picking up.

Then there is -- I think we have four publicly traded vehicles that range from BDCs to closed-end funds to different things, and some do episodic fundraises and some are doing sort of monthly fundraises.

But either way, that's permanent capital and every fundraise just adds to the AUM.

It doesn't run off (multiple speakers)

Those generally leverage the talent you have in place, right?

Yes, absolutely.

So, it's kind of a complicated picture but on balance, this is our fastest growing business in terms of AUM, continues to be.

We think it will continue to be.

It was up 28% in the first quarter.

It will be up, continue to grow pretty fast I think.

But you know, at different parts of the cycle, certain businesses get more momentum than others.

So that's how --

I imagine that you think there's a pretty big operating margin expansion story there given you don't really need additional expense to raise all of these assets?

Yes and a bunch of assets are already raised with the teams investing in them, but they don't start to accrue capital as LT was saying until actually invested.

So that's all complete incremental profit.

Their fee related earnings will lag their fee paying assets because what will happen is they aggregate it and over time it will start to pay.

The other thing I would point out is to add to their growth, they had about $2.4 billion of realizations in the last year, which exited fee related earnings when they sold them.

So that gives you -- add that on top of the 28% growth and you get a feel for how quickly they are moving.

Okay, great.

And then just real quick, did the $0.18 of distributable earnings you posted this quarter reflect the new methodology of excluding investment gains?

It did not.

That was total distributable earnings.

So it's not net.

And you're not going to true that number up until the fourth quarter?

That's correct.

But it's a good point.

It would have been $0.16 or $0.17.

I would have to look at a calc.

$0.16 or $0.17 okay.

Thanks a lot, guys.

Marc Irizarry, Goldman Sachs.

Great, thanks.

Steve, a bigger picture business model question for you.

When you think about the investment you've made in the fundraising organization and the infrastructure for raising funds, still looks like placement fees are still sort of eating into the management fee, if you will.

How much investment do you think needs to take place to really maximize -- you built this great diversified platform, but how much cross-selling are you doing?

And they guess when you think about the growth in your business, is it new relationships or is it more strategies for the same number of relationships?

Well, we've got currently around 1300 limited partner relationships.

They don't all invest in all of our products.

So that's a fall short by us and an aspirational goal to get 100% of our LPs investing in all of our products because we love all of our products and they all performed really quite wonderfully.

And so that's one of the things that we are working on more and more.

And we also as you might imagine even from the perspective of Goldman Sachs where you have high market shares in almost all of your businesses, we don't have a 100% share of reaching all LPs with even one product.

So we're doing two types of exercises.

The first is more and more cross-training between our different in effect sales forces for our individual products.

We're having an interesting meeting next week with all of the professionals at the firm for probably 6.5 hours.

We are putting out a new compensation structure for referrals to encourage this type of process.

We are continuing to add selectively sales and marketing people in areas of the world where we haven't focused as much and aren't as strong.

So we think that there's two ways that we can really grow things.

One is cross-selling and we had some statistics, I don't know if that is in front of us, as to how many -- we can get back to you -- how many LPs basically buy more than one of our product not in the same area, two of our products and three of our products.

So we have those numbers.

Yes, it's about two-thirds of the LPs are in multiple products but it's much lower when you look across all of the products and that's actually the opportunity we are focused on.

One other point on the distribution which is certain products will not lend themselves to being distributed internally.

So if we look at some of the new credit products which are geared towards public markets and retail, we will rely on the best distribution systems that are out there for that.

The other thing, Marc, is we also have done identified another say almost 1200 more potential LPs out there for our products that still are to be conquered so to speak, and so I think it's more products, there's more LPs.

The LP universe changes, LPs exit, new ones appear on the scene and so it's all of the above.

We have a ways to go and on that one and thank goodness.

Chris Kotowski, Oppenheimer.

I was wondering how just philosophically speaking, how important is the concept of net fee related earnings to you?

I mean in the heart of the crisis, anybody just liked any financial institution that was cash flow positive and we all cared about it then, and most of the Street, ourselves included, go around now putting one multiple on your NRRE and another on the performance income and it all gets very complicated.

But it strikes me kind of what you're doing here is you're saying, hey, we had an opportunity to raise an extra $10 billion fund, we really don't care if it hits NFRE.

To what extent do you care about NFRE?

Do you care that it is a growing stream?

Do you care that it covers the baseline dividend?

Do you just care that it is positive or do you not care at all?

Well, we view NFRE as sort of a foundation for the financial strength of the firm.

So what we really care about with NFRE is to make sure that it provides the credit support for our lenders and our bondholders and our access to capital, keeps the lights going and pays the employees a certain minimum base amount.

Growing it over those levels is not a priority for us.

So it provides a floor and after that, what we really try to draw [at floor] is our ENI as we call it, our economic net income.

So we have more than enough NFRE to satisfy the goals of basic financial health in almost any financial storm.

And as a result, when we see opportunities to invest in growth and progress of the business, we will certainly take them because it's what we are really trying to really maximize so to speak is ENI.

But looking at that measure which I think LT considers particularly important, allows for expense discipline because you want to be able to manage on just the management fees alone and it is something the rating agencies look at quite closely as well.

And then secondly, your private equity BCP VI, it was about two-thirds of BCP V and as you mentioned, that was a fairly heroic raise in that environment.

And if I heard you right, you said that in the real estate fund you are launching, you expect it to be at least equal to the prior.

And is that because real estate is a different kind of asset class or is it because the LP sentiment and the willingness to commit capital is better?

Or how should we interpret the difference in relative size of those funds?

I think part of that is the timing of when the private equity funds were raised and the whole introduction of the marked to market concept in effect accentuated perceived declines in that asset class which of course have been rapidly reversing and showed that frankly that way of looking at this asset class is probably not particularly useful from my perspective.

And I think us you were going through that down part of the cycle, going out to market to raise money in the middle of that was challenging as frankly almost every LP in the world was -- either stopped investing altogether or dramatically cut back commitments.

We now are moving into a different part of the cycle where things are rapidly recovering for sources of capital.

Real estate, you know, the cycle is somewhat different because of the huge amount of distressed opportunities that are right before you with a very big increase off the bottom in terms of fundamentals.

But do not be mistaken about this.

The number of people who will not raise a second real estate fund at all or will raise it in a greatly diminished size is a predominant thing in real estate, we believe we will be a significant outlier in that regard.

And also what happened after the shock to the system that LPs got is they tried generally to avoid longer duration commitments.

And of course that's now changing as the world recovers and everybody gets more confident.

So I think a part of this is just simply the severity of that cycle.

And now you can see the healing.

We will probably finish that fund in the next brief amount of time as we get in final subscription agreements and it may well be higher than what you imagine.

And if you are talking about private equity, we are already something over 15 and we'll see where it comes in, it would be.

So we considered three quarters of the last fund which is a great effort considering that we raised at the worst possible time.

The other thing just to note is the scale of that last private equity fund is unprecedented so it's just a higher bar to equal in any environment.

Roger Freeman, Barclays Capital.

Hi, just one, quickly.

Just curious on your thoughts on endowments as an LP class.

I think historically it hasn't been as significant for us as for others.

But one of the things I've been hearing from people actually sitting on smaller endowments lately is they're looking at private equity pretty closely which given kind of what we heard coming out of the crisis, that endowments were over extended, seems like that may have just been the very large ones and a lot of smaller ones kind of never made it to that point and now are looking at it pretty attractively.

Do you agree with that and is that an investor class that you are targeting more?

I agree that endowments now are looking again at their alternatives.

They had a liquidity scare but the public markets have come -- debt and equity have come roaring back and they are now able to do illiquid things again.

Plus a bunch of them moved -- were fairly nimble and moved money into some credit vehicles when they thought credit was very cheap and they're now looking at those credit investments and thinking that's kind of run its course and maybe they ought to redeploy a little bit.

For us it won't be a big target audience though, just because of the scale of the capital, but we do have endowments across our products, make no mistake about it.

Ladies and gentlemen, that's all the time we have for questions.

I'd now like to hand the call back to Joan Solotar.

Great, thanks for joining us and again, feel free to follow up with any questions you might have.

Thanks.

Thank you for joining today's conference.

That concludes the presentation and you may now disconnect.

Have a great day.