紐約梅隆銀行 (BK) 2002 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Mellon Financial Corporation third quarter 2002 earnings conference call. Today's call will be hosted by Martin McGuinn, Chairman and Chief Executive, Steven Elliot, Senior Vice Chairman, and Mikael Bryson, Chief Financial Officer. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I would like to turn the call over to Mr. Steven Lackey, the Director of Investors. You may begin.

I would like to thank everyone for participating in our call. Before we get started I want to quickly take care of some logistics and legal disclosures. First, the slides, including appendix material, related to the topics to be discussed in this afternoon's conference call and webcast can be accessed and downloaded at Mellon's website, www.mellon.com.

The contents of this conference call and webcast and any related material is the property and copyright of Mellon Financial Corporation. This conference call and webcast may not be reproduced, recorded, broadcast, disseminated, published, sold or otherwise used for public or commercial purposes without the express written consent Mellon and the relevant information providers. The following discussion contains statements that are considered forward-looking statements. Actual results may differ materially from those expressed or implied due to a variety of factors that are described in our annual report on Form 10-K, for the year ended December 31, 2001 in subsequent quarterly reports on Form 10-Q, and the slides that accompany the webcast version in this presentation.

These forward-looking statements speak only as of October 15, 2002, and Mellon undertakes no obligation to update any forward-looking statements to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events. Now I would like to introduce Marty McGuinn, Mellon's Chairman and Chief Executive Officer.

Thank you, Steve. In a very difficult market environment, Mellon was able to earn 43 cents per share from continuing operations. This represents a 5 percent increase over last year and, we believe, consistent with the market's expectations. I'm pleased by our ability to continue generating returns that exceed our goal of 22 percent return on equity and are representative of top tier investment performance.

Our aggressive actions, which led to a significant decrease in nonperforming loans and a continued decline in our credit exposure to the large corporate market, are representative of our credit strategy. Corporate lending is not central to our business model. Mellon's focus on performance, product breadth and distribution to both our institutional and high net worth client has offset a difficult operating environment. Our asset management businesses demonstrate as positive net asset flows. We have continued to see solid growth results from asset servicing and cash management.

In the third quarter, asset servicing added $57 billion of custody assets from new clients in the US, Canadian and European markets. This business continues to be recognized for its superior performance, as we ranked at the top of the third key custody survey issued this year; fortunately, our effort to control expenses began sometime ago and we continue to see the benefits of LEAP. Finally, I'm very pleased to announce that our board has approved a dividend increase of 8 percent and renewed our ability to repurchase shares. Now I would like to turn it over to Mike Bryson to review our financial results and discuss our outlook for the fourth quarter.

Thanks, Marty.

I would like to take this opportunity to provide you with some additional detail on our third quarter results. As Marty mentioned earlier, earnings per share from continuing operations were 43 cents for the third quarter, an increase of 5 percent over the 41 cents shown for the prior year quarter. This growth was achieved despite a very difficult operating environment as weakness in the economy and equity markets continued.

The equity markets at September 30, 2002, as measured by the S&P 500 index decreased 18 percent compared with June 30, and 22 percent compared with September 30, 2001. In comparison, continuing operations earnings per share for the second quarter 2002 was 24 cents a share, which included a special provision for credit losses of 23 cents per share, associated in large part with credit exposure related to customers with allegations of accounting irregularities.

Our GAAP diluted earnings per share includes a penny from discontinued operations representing minor true-ups as citizens completed the conversion to their systems in the third quarter. Slide 6 focuses on fee revenue, which comprised 84 percent of fee and net interest revenue. Fee revenue for the third quarter of 2002 totalled $856 million, compared to $923 million for the second quarter of 2002, with a decline resulting from lower trust fees and lower [INAUDIBLE] investment revenue, partially offset by higher cash management, foreign exchange, and securities revenue. [INAUDIBLE] fees, as detailed further in our earnings release and in the appendix to this presentation, investment management fees declined four percent from the second quarter, which is less than implied by the 18% market decline and the 30% of our assets under management invested in equity. [INAUDIBLE] trust and custody fees, excluding the decline in securities lending, were relatively flat to the second quarter, and up 2% year over year. Margins declined in the [INAUDIBLE] area, [INAUDIBLE[ were negatively impacted by a reduction in discretionaries ending by corporations, and equity plan revenues by Mellon Investor Services were impacted by market conditions. Offsetting these declines were trust fees with continued growth in cash management fees, a rebound in foreign exchange revenue, and excellent security training performance. [INAUDIBLE] in equity investment revenue reflect 32 million of unrealized valuation adjustments in the venture capital portfolio, partially offset by three million of realized gains. We also significantly increased in unrealized gains in our securities available per sale portfolio, resulting from lower interest rates, to realize 28 million of gains on sales and securities we viewed to be most at risk, to accelerating pre-payments and [INAUDIBLE]. Even after those sales, unrealized gains in our available per sales portfolio remain $45 million higher than at June 30th. Turning to slide 7, operating expense totalled $756 million in the third quarter of 2002, a decline of approximately 1% unannualized, compared to the second quarter. Our [INAUDIBLE] reflected lower [INAUDIBLE] expenses in the third quarter of 2002, offset in part by higher professional, legal, and other merchant services. This is our third consecutive quarter of reduced expenses, demonstrating an impact of our LEAP program, partially offset by higher benefit expense, and infrastructure expense remaining from our divestitures. I would like now to discuss the third quarter highlights of our core business sectors, as shown on slide 8. Recall that our [INAUDIBLE] consists of three business sectors institutionalized as management, mutual funds, and private vault management. Our corporate and institutional services group consists of three business sectors; asset services, human resources services, and treasury services. In all of these sectors, Mellon continues to hold strong market conditions and top quality ratings. For the third quarter, Mellon's asset management [INAUDIBLE] had positive net asset flows of $3 billion. demonstrating the effectiveness of our global distribution network in adverse market conditions. Operating expenses, excluding a $5 million operational error, declined 2% from the prior quarter. Mellon also continued to invest in it's distribution network and product capabilities. We completed the aquisitions of Weber, Fulton, and Fellman, a Cleveland -based high network investment manager, and private asset management businesses [INAUDIBLE] in the UK, which will be integrated into similar businesses, and HPV Capital Management, a hedge fund manager. In addition, [INAUDIBLE] announced our intention to aquire the separate account business from National Management, which will enhance it's successful efforts in this growing area. Where net flows are up $10 billion on a year to date basis, year over year. Despite the challenging market conditions, the [INAUDIBLE] corporate management will continue to deliver organic growth and assets under management. For the third quarter of 2002, money market net flows were approximately $4 billion, which was offset by one billion of net long term outflows. For the nine months ending September 30, 2002, estimated money market net inflows including flows related to securities lending assets were $15 billion, while estimated long term net inflows were $5 billion, resulting in 3 percent unannualized organic growth.

Market depreciation of $52 billion year to date September 30, 2002, assets under management totalled $562 billion. Which 77 billion were managed by Mellon subsidiaries and affiliates outside the United States. Our balance in assets under management classes tips to mitigate the decline in equity marks. Currently assets under management are comprised of approximately 30 percent equities, 32 percent money markets, and 38 percent in a combination of fixed income, securities, lending cash, and overlay assets.

Turning to the corporate institutional services sector on slide 12, within that group, the asset servicing sector continued to add new business in the US, European, and Canadian marketplaces as 57 billion of new custody assets were converted. Ego investment systems with its industry leading Eagle Pace and Eagle Star software continued to win new business. Foreign exchange revenues were relatively strong, partially offset by weakness in securities lending. Also in the third quarter, we formalized our joint venture with ABM [PHONETIC], Amro and continued to obtain top quality and customer service rankings as CIBC Mellon was rated the top Canadian sub-custodian and transfer agent. At Mellon Investment Services, there was a lower volume of high margin ancillary services such as stock option and stock purchase plan transactions, due to the weak equity markets.

At Buck consultants, clients deferred discretionary consulting engagements in response to the weak corporate profits accounting for a large portion of the linked quarter decline in revenue in the HR sector. The transformation and consolidation of the HR solutions business line continues to progress as planned. The implementation of the previously announced American Express contract is on schedule. Revenues declined, however, as some old unified contracts continued to run off. Cash management, other than, continued to deliver strong revenue growth. In the third quarter, total revenue including fee and net interest revenue grew 20 percent annualized compared to the second quarter, despite reduced levels of corporate credit commitments. Turning to our credit strategy on Slide 14, with our divestitures and exits combined with our strategic acquisitions, Mellon has built an attractive mix of businesses and asset management and corporate and institutional services.

As a consequence, Mellon Bank has reduced its balance sheet and, as Marty noted, the credit product is not central to our current strategy. Within this strategy, Mellon will extend a minimal amount of credit possible to the corporate and institutional market. For existing credit relationships, Mellon will work with those customers to develop an acceptable transition plan. In the third quarter Mellon continued to reduce credit exposure and aggressively dealt with the limited number of problem credits. Unfunded commitments are down 11 percent year to date and our commercial and financial unfunded commitments remain 96 percent investment grade or equivalent. We exited one billion dollars of large corporate exposure. 137 million of criticized credits were sold, including our entire exposure to a customer in the cable and media industry.

We charged off $85 million of Worldcom, reducing our exposure to $15 million, and nonperforming loans were reduced by $108 million, to 67 million, with a California utility expected to emerge from bankruptcy in 2003, representing 58 percent of that total. Turning to the results of the shared national credit exam on Slide 16, Mellon's shared national credit results were markedly better than the industry. Classified credits comprised only 1.4 percent of Mellon's total exposure paired to 6.5 percent for US banks, 7.3 percent for foreign banks and 8.4 percent industrywide. At September 30, 2002, nonperforming loans totaled $67 million. Worldcom exposure totaled $15 million. Exposure to the California-based utility totaled 39 million, as noted earlier. With the remainder comprised of a single commercial real estate credit and a number of smaller loans.

At September 30, 2002, the ratio of nonperforming loans to total loans was 72 basis points and the reserve for loan losses to total nonperforming loans was $188 percent, the highest it has been for all the period shown. As noted on the bottom of the slide, Mellon maintains a separate $52 million reserve against unfunded commitments which needs to be included when comparing Mellon's asset quality ratios to most of our peers who do not separately break out such reserves. At September 30, 2002, total loans outstanding were $9.4 billion. Our loan portfolio continues to be be well diversified. Loans to our private wealth customers totaled $2.9 billion. Large corporate loans to relationship customers were only $1.9 billion, down $200 million from the end of June. Commercial real estate loans totaled 1.3 billion, down 100 million from June 30th.

Total loans by our insurance premium financing subsidiary and our specialized bank in Southern California totaled 1.8 billion. Portfolios in runoff or exit mode totaled 1 1/2 billion dollars. -- including large-ticket leases of $700 million and credit exits of 600 million. The latter are loans we will exit at the maturity of their underlying commitments unless sold earlier. Finally, look at Capital Management, on slide 20, in the third quarter of 2002, Mellon continued to aggressively manage its capital base. In the quarter, a total of 5.1 million shares were repurchased, bringing the year-to-date total to 19.4 million shares. At September 30, 2002, common shares outstanding were a net 17.7 percent lower since January 1999, reflecting a 92.9 million net share reduction.

There are currently 3 million additional shares available for repurchase under 259 million-share program authorized in November of 2001. Finally, the board has approved an additional 25 million share repurchase authorization and we increased our quarterly common dividend 8 percent from 12 cents per share to 13 cents per share. Now let's turn to the outlook for the fourth quarter. First for the asset management group. The year-to-date results of the asset management sector have been impacted by equity market conditions for which the timing of a recovery is very uncertain.

For the fourth quarter, we are assuming an S&P 500 range of between 800 and 900 in our guidance. In the fourth quarter, investment management fees will include Newton performance fees. Overall, the balance in Mellon's assets under management classes mitigates the downside risk of equity markets. As a general guideline to gauge the market sensitivity of our asset management revenue, a 100-point change in the S&P 500 sustained for one year results in an aggregate change of approximately 45 to 60 million in investment management fees.

Net of incentives; this change in revenue estimates a 6 cents to 7 cents per share impact. In terms of individual security to the revenue sensitivity, is 20 to 25 million per institutional asset management, 15 to 20 million for mutual funds and 10 to 15 million for private wealth management.

For the corporate and institutional services group, the new business pipeline remains positive, but the sales cycle has lengthened as corporations defer spending decisions. The weak economy and equity markets are impacting consulting and equity plan servicing mandates respectively. The integration of our HR solutions business in the human resources services sector is proceeding as planned, as are our outsourcing contracts; but we caution against expecting anything but very modest near-term growth.

Foreign exchange, securities trade, and securities lending revenue will continue to be influenced by external market factors. We expect a modest decline in net interest revenue for the fourth quarter compared to the third quarter. Operating expenses are expected to be well controlled. With the continued repositioning of the credit portfolio, we expect provision expense to be approximately 5 to $10 million. Finally, we will continue to manage other capital utilizing earnings net of dividends for investing in organic growth, fee-based acquisitions, and share repurchases.

All while maintaining a targeted tangible common ratio of 5 percent and well capitalized ratios for regulatory purposes. Given these factors, and recalling our 800 to 900 range for the S&P 500, Mellon is currently comfortable with a fourth quarter diluted earnings per share range for continuing operations of 41 cents to 43 cents per share. For the full year, that translates to a diluted EPS range of $1.55 to $1.57, which includes the impact of the 23 cents per share from the special loan loss provision recorded in the second quarter. Excluding this charge, our full-year earnings per share guidance would be a range of $1.78 to $1.80. This concludes our presentation. And Marty, Steve Elliot, and I are open for questions.

Thank you. At this time, we will begin the question-and-answer session. If you have a question, press 1. You will hear an acknowledgement that you have been placed in queue. If you wish to be removed from the queue, press the pound sign. Your questions will be queued in the order that they are received. If you are using a speaker phone, please pick up the handset before pressing the numbers. Once again, if there are any questions, please press the 1 on your touch-tone phone. I have Henry McVey from Morgan Stanley online. Please state your question.

Can you hear me?

Yes.

Just a couple of quick questions.

One, can you comment on the institutional asset management margins there, dropped off again, I think they were, uhm, less than 9 percent down from a peak of, you know, 25 to 35. What's the outlook there? And then second, you mentioned on the HR services two things. One was that you had runoff of business, well -- will that continue going into the fourth quarter? And just -- or is it really just that, uhm, the discretionary spending is slowed at box? And then the third thing is give us an update on venture capital. You took a little bit of a hit there. Will that continue in the next quarter or is most of that done?

Let me ask Mike Bryson to comment on the and then Steve, he will talk to the HR solutions business and also the venture capital.

You know, Henry, we have had a steady decline in the margins in that business, as you know now, for a number of quarters. And I think as we pointed out previously, a good bit of that -- some of that decline is obviously the market. A good bit of that decline to date has been the result of some lower margin acquisitions, standish air and wood and then an entity in Australia that's in the sort of bundled 401(k) equivalent business. And also, the buildout of our distribution in the internationally and Mellon global investors in London.

I would point out that from the second quarter to the third quarter, you have to take into account the $5 million operational error that we noted which is an expense because that was a significant contributor to the decline in margins. But I think, you know, the rest of it is really the market and as we've said, we do expect through our efforts for those margins to begin to improve. But in this quarter, that operational error particularly hurt.

Right.

But so are you saying is that a 2003 event or do we start to see some improvement even if you add back for the one-time $5 million, does that start in the fourth quarter or is that pushed off until '03?

I think you'll see it in the fourth quarter in part --

Excluding the performance --

Well, that's -- since we don't, you know, quite know what they are going to be, it's -- it's difficult.

I think we should see some -- and again, I don't know where the market's going to be, too because as you know, in that business when your revenue declines, it's very difficult to reduce revenues, you know, to the same degree. I'm sorry, to decrease expenses to the same degree. But I do think that, you know, we're working very hard to begin to reduce expenses and I -- I think we should begin to see a bottoming out in the fourth quarter and hopefully improvement in the first quarter of next year. As you know there will be an improvement in the fourth quarter because of the performance fees, but you'll have to sort of normalize for that.

Okay. Just on the HR services?

This is Steve Elliot. Let me take that one, Henry.

Okay.

In the HR side, we had three businesses that make that up that sector. Buck the consulting side, obviously we have continued to see the slowdown of I'll use the word non-actuarial, non-health and welfare type assignments. Those will continue to be fairly strong here throughout the summer as a lot of companies are looking at their medical costs for 2003 as well as obviously their pension plan expense for next year.

What we're real -- where we're really seeing the falloff is in the compensation practice, the communications practices, all those discretionary things that HR directors frankly continue to put on the shelf and at this point in time, I have a hard time seeing in terms of any catalyst, if you will, for that to change here in the fourth quarter. The other thing you do have to take into account is if you look at historically, seasonally, the fourth quarter for Buck is traditionally light. If you look in terms of the number of work days in the fourth quarter, and taking into account holidays, the time and billing side of Buck, if you will, is influenced in that there are less billing days and you'll see somewhat of a seasonal comeback in the Buck side. Going to HR Solutions, as Mike indicated in his comments, some of the old unified contracts that were -- where we had been notified prior to acquisition continue to run off and that phenomenon will continue to be with us throughout 2003, obviously diminishing each and every quarter as we work out from the positive aspect of all that, those were contracts that Mellon did not pay for and they in essence have been kind of a bonus, to you also to us here in the short run.

Our big contract continues to work, work well that will continue to build as we go into the midyear of 2003. And right now, the pipeline in HR solutions is extremely strong. There is a number of -- a number of potential activities there, but again, the sales cycle is slow and the revenue from anything that we are looking at today really doesn't come on until the second half of 2003. And the final sector is investor services.

Again, equity markets have reduced corporate actions. The administration of stock purchase plans, stock option plans, are way off and we need a better market here, little better market tone to get more activity there. Having said that, the business is very well managed there and I would expect their fourth quarter to be at or above the third quarter results.

The other question was around the venture capital side. What we've -- obviously tried do here is to be very contemporaneous with where we stand with venture capital, recognizing the environment around us on a company-by-company basis.

You know, we've slowed significantly, not only new investments but also follow-on, only doing follow-ons where it made sense with respect to continuing to look in terms of the ultimate outcome of an investment. We think we're well reserved as we sit here at September 30th, but obviously it's a on going -- ongoing situation that you have to evaluate each and every quarter.

Okay. Good. Thank you very much.

I have Judah Crawsure from Merrill Lynch. Please go ahead.

I have a couple of questions. I'm not sure who wants to take it. I'm curious on the terms flow here. I think this is the first quarter where we have had a slightly negative number. While your total flows have been very good, it's been skewed increasingly over the last year towards money market assets.

So I'm just curious, sort of how you're evaluating these term flows and in particular whether you're seeing any specific performance issues either in the equity mutual fund area or broadly in the institutional business that may be sort of an out sized factor. I have a feeling there may be some issues on the institutional side of which I'm hoping you might be able to address.

Let me start and then ask Mike or Steve. That's a very broad question, of course. I mean, starting with Dreyfus, the equity performance has been mixed. But where Dreyfus has done reasonably well is in the institutional cash management and in the money market funds.

And while the margins on those is less than the equity funds, nevertheless there have been substantial net inflows which have helped that business significantly. This year. On the institutional asset management side, again, with 14 different subsidiaries, it really varies. Newton and several of the others have continued to show very strong performance on a relative basis.

Two of the areas where we had some performance issues such as in standish Mellon and in Mellon equity, we have actually seen even a couple of quarters now of significant improvement which will start to be factored in. So I would say there really aren't any significant outliers, you know, compared to general market conditions. But let me ask Mike or Steve if you have any --

I'm just curious, too, in that last comment you made on Mellon equity and Standish whether you have pulled that out of a mix -- whether most of your outflows are in those two areas.

No. They are not, to answer your question. But Mike?

Definitely not in this quarter, Judah. As I think you know, there have been some out flows there in prior quarters but their performance has stabilized, not in this quarter. I would only echo Marty's comments. I don't think there's any particular issue here other than the condition of, you know, the external markets.

Two other unrelated questions.

I just wonder about the non-performing assess [INAUDIBLE] drop which is reassuring, you take out the Worldcom charge you still have another 22 million drop in non-performers last year. Can you help us understand what's behind that? When you look at classified credits, you mentioned the shared national exam. Are you really feeling good that there is nothing substantial now in the pipeline that could --

Judah is tossing the fastest softball known to man to Mellon management. (Pause).

Sorry, what was that?

They said, sorry, what -- (Pause)

Hello? Can you hear me? I don't know what that was all about.

Nor do we.

Basically, I was just hoping you can give some color on the 22 million drop above non-performers above and beyond Worldcom and lastly, just shift gears if you could, talk about the asset servicing revenues. Even if you pull out securities lending fees, it was down this quarter, I just wondered what the pipeline looks like and why that -- why it didn't get some growth there this quarter.

Judah, it's Mike on the -- on the non-performers, you're right, there was, uhm, other than, you know, Worldcom, there was 20-some million of further reductions. Those really came from, uhm, sales of loans that were in PA, and in a couple of the cases they were sort of residual pieces of loans we had sold parts of previously. So, you know, we -- as you can see from I think it was, you know, one of the slides, Slide 18, in the presentation, there is really nothing left there. We just sold virtually everything out that we could sell. And, uhm, Steve --

Yeah. On the asset servicing side, ex-securities lending, yes, it is pretty flash quarter to quarter. I think the encouraging thing to us, Judah, the amount of net new wins that 57 billion that Mike was referring to that was a net 57 billion. Obviously, that came on as we went through the quarter and will start to recognize the revenue from that as we get into the fourth quarter in early 2003. But gross -- gross wins were well in excess of that 57 million and what we shared with you was the net number. I would just view it's part of the timing aspect of business going in and out here and no particular underlying trend.

But on the pipeline, I would add that with the rumored sale of a major custody business, the feedback we're getting from the field is there are already lots of requests for proposals going out and many more expected to come.

And are your custody assets up so far this quarter or.... I mean the fact that you had 57 billion of net new wins --

You in essence saw it in the third quarter. We were in essence flat versus June 30th, Judah, and obviously with equity markets down 18 percent, I --

I just wondered whether you could you know sort of get some sense of where you think the fourth quarter is going to come out on the net new win basis, whether there will be a meaningful additional increment.

The biggest factor is what the markets do here in the fourth quarter. But again, I would expect us to be net positive. I'm not aware of any major piece of business that frankly is going to [INAUDIBLE] here in the fourth quarter.

Thank you.

Mark Fitzgibbon from Sandler O'Neill is online. Please go ahead.

Hi, gentlemen.

I have three questions. My first question is, I wondered if you could comment on whether or not you are getting any traction in the back office outsourcing business if you could sort of give us an update there. Secondly, I wondered if you could also give us a sense for whether you think you can pare down, substantially move your corporate book? And then finally, I also wondered if you could give us a sense for what the operating expense line is likely to look like in '03.

Let me comment generally first.

Are we getting traction in the back office outsourcing, the, uhm -- the trust company of the west outsourcing has gone extremely well and with the addition of Eagle's capability, we're also looking to convert a lot of our internal investment management companies, which is a important -- which is important for us longer term. But, yes, we are seeing many more opportunities going forward in the external markets. Part of the difficulty of assessing the future, though, is the [INAUDIBLE] we're seeing on decision-making by so many of our clients, and even though we can win mandates, a lot of them aren't actually being triggered as fast as we would like. But the other question was the --

The paring down the large corporate loans.

Large corporate loan book. We are doing that as rapidly as we can. I mean, keep in mind, one of the large problems there is that we are bound by contracts in many cases. Also, as we noted, with existing customers, we are trying to work with them as we can to the extent of -- that we recognize our commitment, which we have been very forthright about of wanting to work down the portfolio as well as our commitments. And I think what's helping us in this regard is the fact that it is consistent with our strategy, which has been fairly explicit for several years now.

And secondly, that many of our competitors in the other businesses which we're trying to protect or win from clients are provided by competitors that don't extend credit themselves. So all I can say is we are working that down as rapidly as we can.

Mark, it's Mike Bryson. I would add that, you know, if you are focused on loans, there is a billion and a half of loans in sort of what we called our exit category, and that will run off. There is only a billion nine of additional large corporate loans outstanding at September 30.

So there's, you know, not a lot of opportunity for reduction there. So it's really the unfunded commitments that, you know, we have to be focused on trying to bring down. And, of course, those are, you know, virtually all investment grade. So it's a little tougher. But on the loan side, there really isn't a whole lot there was the point I wished to make.

Okay. And on the expense line for next year, what would you guesstimate a reasonable growth rate would be?

Well --

Well, let me interject for what Mike was going to say. I mean, what we've been trying to do, and you've seen in the last three quarters, is actually hold expenses flat or down.

And as we are well into the planning cycle for next year, we're looking at an individual business basis, at this point looking where we have the revenue growth and where we've got to really emphasize positive operating leverage. Part of it is going to depend really over the next next several weeks and months as to how we see the external environment. But depending on where we see the potential for revenue growth or not, we will continue to manage the expenses very, very aggressively and a lot of our LEAP savings continue to kin in on a run rate basis, as well.

Yeah.

I would add, Mark, one of the reasons why I think it was tough to give anyone a number right now is I think everyone out there knows that they're facing higher healthcare medical benefits costs for next year, and I think everybody also knows they are facing either higher pension expense or lower pension credits. And we'll try in our upcoming 10-Q to provide some sensitivities certainly around the pension issue, but those are two issues here that -- that you know, can be sort of offset to what otherwise would be, you know, continued strong expense management.

And you have to, I think, put on top of that, Mike, business insurance rates continue to be very high in relationship to historical patterns as well as we're all faced with higher business continuation expenses for next year which will go into even '04 and '05.

I have John Coffee from Citigroup Asset Management Group online. Please go ahead.

First of all, I would like to thank you for the enhanced disclosure. I know you guys have worked hard at that it's very helpful. Secondly, has there been some sort of a change of heart on the capital side? I'm specifically referring to the decision to increase the dividend 8 percent I guess less than a year after you cut the dividend in half. Is that because, uhm, perhaps you see less opportunity for acquisitions given the I think the what Marty mentioned the possibility of Deutsche Banc business going to State Street?

Uhm, John, it's Bryson. I'll answer that I mean, the increase in the dividend will cost us $4 million a quarter. That doesn't buy back very many shares and doesn't make much in acquisitions. So I think all it really is, is something that is maybe a little more meaningful to a certain class of investors but from a Capital Management perspective, it's really not significant.

Okay. So we be conditioned to expect more dividend increases over time even though the earnings are relatively flat right now?

Well, I mean, as earnings grow, we will, you know, continue to look to increase dividends as we also, you know, look to continue the uses of capital for acquisitions as well as stock buy-backs. I think we set a pretty good record in terms of our actions of how we manage that capital. And we don't expect to have any major change in that approach.

Okay. Thanks.

Tom McCandless from KBW is online. Please go ahead.

I want to follow up on the last question that John asked. Could you share with us what your capital guide lines are, specifically your tangible common targets?

Tom, it's Mike Bryson again. I think we've been, you know, quite consistent sort of over the years as to saying that we view our constraint as maintaining a 5 percent tangible common shareholders equity ratio. And as you may note from our press release we were at 4.99 percent here at September 30 so that's managing it, you know, fairly tightly. I think that's the ratio that we manage to. Obviously, we will always be well capitalized from a regulatory perspective. But it has tended to be that that tangible common share holds equity ratio as we measure it at 5 percent is the constraint [ shareholders equity ratio ]

Okay. That's great. I have a follow-up question. I -- this perhaps is a instead of a question, a point of clarification on my part. Just trying to better understand, uhm, what your expectations are for new business. I think Marty suggested that, you know, it's -- you can win mandates but delivery is postponed or deferred. Can you talk about in the third quarter the amount of new business that was won but, you know, looks to be installed in the fourth quarter? Is it meaningfully different than the activity that occurred in the second quarter?

Well, you know, again, there are so many different businesses with different dynamics.

I -- and again, so much of it depends on the environment. When in August we thought we were seeing particularly in institutional asset management some very, very good wins that were an increase over what we had seen in the second quarter, but frankly, the uncertainty in the marketplace today, whether you attribute it to the possibility of a war with Iraq or whatever, you know, just continues to be uhm, I think a depressant on decision-making. Whether that kind of thing can shift, you know, in the short term, I think, just remains to be seen. So I don't know, Steve or --

Tom, this is Steve. One area where we really saw the brakes put on in the third quarter as contrasted to the second quarter was in the consulting side of Buck. You know, through -- oh, late May into June, things were tracking extremely well and really on our business plan. And it really was late June through the end of the third quarter and into the fourth quarter here that the decision-making really is -- has come to a halt, if you will.

I have Denis LaPlante from Fox-Pitt Kelton online. Please state your question.

Good afternoon.

On LEAP, if you could talk about where you are in the run rate in terms of the cost savings realizations, and talk about your attitude about initially when the leap program came up and you were pretty early on I guess among your peers in terms of trying to think about the future and looking to cut costs, you talked about using that as a lever rather than reinvesting. How much of a lever do you have next year in -- I may have a follow-up on that.

Well, when we began LEAP at the beginning of last year, we obviously were concerned about the external environment and we had targeted approximately $300 million in benefits, about two-thirds of which were cost reductions. We are on track, in fact we had an implementation meeting just Friday. And we're even above that now. We're closing in at around 312. And obviously, it's very hard to measure what's incremental and what's a result of LEAP as opposed to what's the result of other actions, although we're working very hard to do that to make sure in fact we get the incremental benefits.

But I would say we expect to have all of the benefits in the run rate by the end of the first quarter of next year and as I said, we're on track for a little more and on the timing, on schedule, as well. The real question for us as we go through the planning process is to what we want to do additionally. As I said earlier, that's going to depend on each individual business and just where we are with that business in terms of our revenue targets and what we have to do on the expense side, which we can manage to a larger degree in order to be able to achieve our targets.

Of that 200 million, or 50 million a quarter, where are you right now at the end of the third quarter?

Uhm... Denis, this is Mike Bryson. I would say we're, you know, we said there were 7 quarters in LEAP. We're through 5 quarters. I would say we're at a run rate, we're about 5/7ths.

But the point I did want to interject which we have tried to point out is that probably 25 percent of our overall LEAP savings, or maybe a little over a third of the costs savings of LEAP, you know, the 200-plus million cost savings, about a third of that you know, you are not going to see it because what that's really doing is right-sizing our infrastructure that would otherwise be sort of underabsorbed expense following the divestitures that we accomplished last year. So that you are not going to see that amount sort of fall to the bottom line. And I think the other point I would make is that where you don't necessarily see it falling to the bottom line is, you know, we talked about higher medical benefits next year, lower pension credit, next year. We have actually had that hit this year. We have had higher medical costs this year and a lower pension credit this year. So you have things like that, that are -- that when you do sort of an analysis here, you don't -- you know, they're offsetting seeing that expense fall to the bottom line. Having said that on a sequential quarter, those 1 percent declines you're seeing I think are LEAP.

That's why I emphasized that we have this implementation team in place to really make sure it's incremental to what would have been the case otherwise. But just as money is fungible, there are an awful lot of ins and outs, you know, quite separate from the LEAP process. I don't intend that to sound vague, by the way, or evasive. It just is the reality of managing it through, which is why we are spending so much time making sure we are getting the incremental benefits.

I have Christopher Marknack from SunTrust online. Please go ahead.

Yes, thank you. Question regarding acquisitions in the private wealth management business, Marty. You had mentioned that that was a key focus for to you build externally. Is that still the case and are you seeing better pricing in today's environment?

Yes, it still is the case. Sometimes we're -- I sometimes see better pricing. It's still very difficult for two reasons. One, the expectations that sellers have built up over time.

And secondly, it still is a competitive process and others maybe need to expand in that area or have a different strategic view and are willing to pay more than we are. But it does continue to be a priority for us. We want to make sure that they fit our culture and fit our strategic priorities. But we'll continue to be very disciplined on the financial side, too, to make sure that it is neutral to cash earnings in the first year and that we pay what are appropriate prices. But we continue to see a lot of opportunities and we continue to look to take advantage of them.

Marty, do you feel that this is the time to be contrarian in terms of building for the long term in this particular business?

You mean contrarian in what sense?

Just the sense of building the network further on the private side when the markets are soft?

Oh, well, yes and that's why we thought there would be more opportunity to continue to look for them. I should also add that we continue to hire individuals and groups of individuals with good books of business and with extremely good experience. And that kind of acquisition, if you will, has also been an important part of how we're adding potential growth.

Great. Thank you.

I believe we have time for one more question. Our final question today comes from Claire Percarpio from Janney Montgomery.

You said that you won't use credit as central to your business model.

You know, Marty, are you saying that you're really going to change your long-term model on how you, you know, make your proposals to customers, or is credit just sort of, uhm, or are you just holding back sort of for an interim period until we get through this cycle?

Oh, no, no. I'm glad you asked for that clarification. And let me say it a little differently than before to hopefully clarify.

As far as new business is concerned, we are viewing that as not being in the credit extension business. Now, will we have to make some exceptions to that? The answer is probably. But we will do it on a one-off exception basis and the first question will be whether it will meet our very strict credit criteria, not as a lead for other business. As far as existing customers go, where we've got credit outstanding, that's where we're a little more limited.

Frankly, we had been approaching it on a reduction basis. We have now turned it around and are now saying that we really want to have zero credit, even with existing customers but we have to manage that down within the realistic confines of if contracts and relationships and there we are doing it very aggressively but again, on a credit-by-credit, name-by-name basis with our customers. But this is not a cyclical thing.

This is very much the evolution and consistent with our strategy, where not only has our strategy, I think, been made very explicit and as we have been narrowing it and taking actions consistent with it, but also our balance sheet has been contracted, too. So all of this we see as the very explicit outcome of that strategy and the implementation of it.

And Marty, what you -- do you think your competitors are doing or will do? I mean, have you seen a change in them yet?

Well, sure. We do see our competitors particularly, you know, the large syndicated lenders, trying to use that as leverage as they build syndicates or try to sell their own business.

But again, we think so much of our services now really depend on the quality of the service and really are not the kinds of things that you change overnight.

I mean, whether it's outsourcing your Human Resources department which you obviously don't do on a whim and our other competitors don't even extend credit or even in some of the other businesses like the outsourceving a back office or even a custody of assets again, those are not changed very lightly and we think the quality of our services and the oppressiveness of our market position help extensively. Now, having said that I have to be very candid, and this is a management challenge because we have to work through a transition and we have had some customers threaten to take away other business and I'm sure we'll face that from others, as well. But we're committed to working through this. This is not just a cycle issue. This is very much a part of the implementation of our strategy.

Operator, I think we're finished. We would like to thank everyone for participating today.

This concludes today's conference call. Should you have any follow-up questions, please contact Steve at 412-234-5601. Or Andy Clark at 412-234-4633. Mellon Financial would like to thank you for participating. Thank you, Marty and Steve.