紐約梅隆銀行 (BK) 2004 Q4 法說會逐字稿

Welcome to the Bank of New York's fourth quarter 2004 earnings conference call.

Today's conference is being recorded.

The information and materials contained in this conference call and webcast and any related materials are owned or licensed by the Bank of New York Company, Inc. and may not be copied, displayed, retransmitted, published, broadcast, modified or otherwise used for public or commercial purposes without the express written consent of The Bank of New York Company, Inc. and the relevant information providers.

If you would like to ask a question at the conclusion of today's presentation, you may do so by pressing star one on your touch-tone phone at any time during the presentation.

Now Joe Murphy, head of Investor Relations for the Bank of New York Company , Inc.

Good morning, everyone, and thanks for joining The Bank of New York's fourth quarter earnings call.

Before we begin, let me remind you that our remarks may include statements about future expectations, plans and prospects which are forward-looking statements.

The actual results may differ materially from those indicated or implied by the forward-looking statements, as a result of various important factors including those identified in our 2003 10(K) and our most recent 10(Q).

Forward-looking statements in this call speak only as of today, January 19, 2005.

We will not update forward-looking statements to reflect facts, assumptions, circumstances or events which have changed after they were made.

Now I would like to turn the call over to Tom Renyi, Chairman and CEO of The Bank of New York Company.

Thank you, Joe, and this morning with me as well as is Bruce Van Saun, our Chief Financial Officer.

I'd also like to welcome you to The Bank of New York Company's conference call to review our fourth quarter earnings release of this morning, January 19, and to provide additional insight into our performance and strategy.

First, I'll provide some brief comments on our fourth quarter results; then I will turn it over to Bruce, who will provide a more detailed review of performance this quarter; and I will come back with closing comments focusing on where we are today as a company and providing a preview of what we expect in 2005.

And then we'll open it up for questions.

Overall, our business model responded well to the improvement in the market environment during the fourth quarter.

With the exception of equity volumes, the environment in October was still relatively weak, particularly for fixed income volumes and equity.

But it wasn't until after the November elections that market activity really recovered across the board.

For the quarter, equity volumes led the way with the NYSE and NASDAQ nonprogram trading volumes for the quarter up 16 percent sequentially.

Equity prices rallied post-election, with the average S&P 500 finishing up 5 percent for the quarter.

NASDAQ was up 10 percent and the FTSE was up 6.

Fixed income volumes also recovered from a week third quarter and were up 8 percent led by treasuries and mortgage backs.

We also saw is some better levels of cross-border activity and FX volatility, as the dollar fell versus major currencies throughout the quarter.

Given that our business model, by design, touches all these markets, our servicing and fiduciary revenues responded well to this environment.

The best performer for the quarter was execution in clearing, which is most closely tied to equity volumes.

DRs also reacted well to the higher levels of activity, including increased capital raisings and seasonal dividend activity.

FX and other trading benefited from the increased activity in the currencies market and better flows in equity trading.

Investor services generated strong performance based on continued new business momentum and better environment in the last 2 months of the quarter.

We remain well-positioned from a balance sheet perspective, with continued growth in NII throughout this rising interest rate period.

We were somewhat disappointed with expense growth this quarter, which was impacted by several factors which included higher incentives tied to performance, and increased level of outside help that was associated with converting some new outsourcing wins, and increased staffing in some of our key growth areas.

On balance, our performance for the quarter translate into EPS of $0.45 and $0.48, excluding 3 cents from several items that Bruce will describe in a little bit more detail.

On a full year basis, operating income increased from $1.67 in '03 to $1.85 this year.

And -- and $1.88, excluding the $0.03 of special items in 2004.

As I said earlier, the full performance reflects the benefits provided by our diversified group of businesses, as well as outstanding results in the credit portfolio.

While the credit portfolio has helped -- has been helped from a strengthened environment, our low credit provision this year also represents a dividend on the work that we've done over the last several years to reduce exposures, improve granularity, and lower risk.

And while the provision naturally will rise from this very low level, I am confident that our credit costs will continue to be lower and less volatile as a percentage of the portfolio than what we have experienced historically.

With that, let me turn it over to Bruce for some more detail on the quarter.

Good morning.

The highlight of the quarter was clearly the bounce back in revenues.

But before I provide color on our core business activities, let me take a moment to address in more detail several items that we highlighted in the earnings release which in the aggregate reduced EPS by $0.03.

The first item is a 52 million after-tax benefit resulting from customers in our lease portfolio electing to exercise early buy-out options on a number of large cross-border leveraged leases, mostly involving rail cars and other railroad equipment.

Given a variety of economic factors, the economic value of the leased equipment is significantly greater than originally anticipated, exceeding the early buy-out option price.

During the fourth quarter, we offered financial incentives to these lessees to accelerate the decision to exercise their early buy-out options.

As a result, several lessees agreed to the proposal.

Under FAS-13, we are required to make cumulative adjustment to the lease balances since we're essentially recognizing the lease income over a shorter time period.

This cumulative adjustment results in an 89 million increase in net interest income, which net of taxes is a 52 million after-tax gain.

The next credit related items are effectively offsetting.

During the fourth quarter, we entered into a lease restructuring agreement with a abrupt domestic airline line which reduced the cash flow we will receive under the lease.

This change also requires a cumulative adjustment to the lease under FAS-13, which in this case reduces net interest income by 5 million.

In addition, with respect to two aircraft leased to another airline, we had a gain of 3 million on the residual value of one aircraft lease, offset by an adjustment of 5 million to the residual value of the other aircraft lease, resulting in a net expense of 2 million.

The gain was booked to Other Income, while the loss was booked to Net Interest Income.

Given our strong credit metrics during the quarter and the fact that the bankrupt airline exposure was fully reserved, we had a negative provision during the quarter of 7 million.

This effectively offset the impact of the aircraft lease items.

The third item is a 22 million after-tax charge related to the possible resolution of an investigation of an alleged fraudulent scheme by a former customer of The Bank.

As we outlined in last quarter's 10(Q), we have been in discussions to resolve this investigation.

While there can be no assurance that a settlement will be achieved, the 30 million charge in Other Expense includes 24 million in expected settlement costs and 6 million in legal fees related to the matter.

Only a portion is tax deductible, so the after-tax impact is 22 million.

The last item relates to the potential outcome of our discussions with the IRS on certain types of structured cross-border leasing investments, generally referred to as LILOs.

As we outlined in last quarter's 10(Q), we explored a settlement proposal in the third quarter, but were unable to reach agreement.

We had two conferences with the IRS Appeals Office in December, and now believe it may be possible to reach an acceptable settlement.

While there is still no assurance that we'll -- that we will reach an agreement, based on our revised estimates of the probabilities and costs assigned to litigation and settlement, we have recorded an increase of 50 million in income tax expense in order to increase the tax reserve on these transactions.

Now let me shift the focus back to providing color on the strong performance in our core servicing businesses.

Noninterest income was up 7 percent sequentially and 8 percent versus a year ago, as our diversified business model responded well to better market conditions across most of our product segments and continued to deliver organic growth through new business wins.

Our execution and clearing businesses were most directly impacted by the improvement in equity market volumes.

These fees came in at 302 million, which is up 15 percent from the third quarter.

Typically, our results in this segment would not be so closely correlate to do overall market volumes, given the high percentage of non-transaction based revenues at Pershing.

The performance does reflect particularly strong results in our execution business.

In addition to better market conditions overall, execution benefit from significantly higher activity levels in transition management and a large number of portfolio rebalancings during the quarter.

This activity drove BNY brokerage share volumes up 32 percent from the third quarter, while international G-Trade principal volumes were up 19 percent.

On the clearing side, Pershing was positively impacted by both increased trading volumes and higher equity prices.

Billable trades were up 19 percent, higher than the market trend.

And while the majority of Pershing's revenues are from non-transactional activities, like asset gathering and technology services, these areas showed strong growth as well.

Pershing assets under administration were 706 billion at quarter end, up 9 percent versus 9/30, and in line with the growth in the S&P 500.

Margin loans increased slightly to 6.1 billion from 5.9 billion at September 30th, which is not unexpected since retail margin balances typically lag increases in activity and prices by 2 to 3 months.

The next servicing category, Investor Services, increased by 5 percent to 239 million, and was up 14 percent year-over-year.

The sequential increase reflects continued organic growth and better market activity in November and early December, partly offset by some pricing compression in the custody business.

Within this category, global fund services continues to benefit from the conversion of new business wins in Europe, as well as the continued addition of new clients to our hedge funds servicing platform.

Total assets under custody increased to a record 9.7 trillion at year end, up from 8.9 trillion at September 30, and 7.9 trillion a year ago.

The percentage of custody assets and equities at year end was 35 percent compared with 33 percent at September 30.

Securities lending fees increased relative to the third quarter, as higher activity surrounding treasuries in December lowered our cost of funding, there by increasing our spreads.

This out weighed lower spreads earlier in the quarter resulting from the timing of the 2 Fed rate increases during the quarter.

Global liquidity services fees were also up, as we were able to benefit from higher fees related to rising rates.

The next category, Issuer Services, was up 6 percent sequentially from the third quarter and up 10 percent from the fourth quarter of '03.

The sequential increase primarily reflects higher activity levels in depository receipts.

After a slow start to the quarter, DR trading volumes increased significantly in November and were up 13 percent sequentially this quarter.

Issue and cancel fees also improved due to higher DR volumes, as well as an increase in capital raising and M&A activity.

DRs also benefited from the seasonal pick up in dividends in the fourth quarter.

Corporate trust fees were up modestly in the third quarter, despite global debt issuance declining by 3 percent sequentially.

The increase was driven by continued strength in international issuance, including the recently announced exchange offering for Argentina and consistent growth in corporate specialty products.

The final category, Broker Dealer Services, declined by 4 percent sequentially to 52 million, but was still up 8 percent year-over-year.

The decline reflects a seasonal slow-down in activity in global collateral management, as many clients tend to unwind positions at year end, but we continue to see growing demand overall for our collateral management services and expect a rebound in the first quarter.

Private Client Services and Asset Management continues to demonstrate solid performance with fees up 2 percent sequentially and 12 percent year-over-year.

Total assets under management increased during the quarter from 97 billion to 102 billion, driven by higher equity prices and organic growth in institutional equity management.

Ivy Asset Management, our fund to funds hedge fund manager, continued its solid growth and finished the year with assets under management of 14.8 billion, up from 9.1 billion at the beginning of the year.

Foreign exchange and other trading rebounded significantly from the very weak third quarter as the market environment improved for both foreign exchange and our other trading activities.

For the quarter, revenues increased by 23 million versus the third quarter, with strength in both foreign exchange and our retail flow business at Pershing.

FX activity began improving early in the fourth quarter, driven by the steady decline of the dollar which stimulated cross-border trading activity and increased volatility.

Other trading benefited from higher volumes on our equity desk at Pershing, reflecting the stronger equity environment this quarter.

Turning to net interest income, the story remains positive as NII on a core basis was up 5 percent versus the third quarter on a taxable equivalent basis and 7 percent versus prior year.

The sequential increase resulted from a higher volume of interest-free deposits and an increase in their value given the 2 Fed rate hikes we saw this quarter.

The growth in deposits stem from both more activity in our servicing businesses, as well as discussions by global payments customers to leave higher compensating balances to cover services rather than pay us in fees -- a result of the rising rate environment.

Our asset sensitivity did not change much during the quarter, although the benefit from lagging deposit repricings as rates increased will start to trend down.

We continue to be comfortable with our positioning, given the anticipated gradual rise in short term rates.

Expenses were the one area of disappointment this quarter.

While noninterest revenues increased by 6 -- 6.6 percent on a sequential basis, core expenses, excluding the items outlined earlier, essentially equaled this growth at 6.8 percent sequentially, negating any potential benefit from operating leverage.

The bulk of this growth was in salaries and employee benefits, which increased by 53 million sequentially to 617 million.

Now, this growth was driven by several factors.

First, incentive compensation was naturally higher reflecting higher revenues, particularly in our execution and clearing businesses.

Second, converting new business, particularly some of the recent outsourcing wins in Europe, front loads costs which are not matched with revenue.

Third, outside help was higher than normal this quarter as we completed projects designed to upgrade product capabilities in clearing and investor services.

We also increased headcount in some of our key security services business areas to better position us for future growth.

Clearing and custody expenses, which are both tied to transaction volumes, were up by 12 percent on a combined basis to 67 million, in line with activity in the underlying businesses.

Other operating expenses, excluding the RW matter, increased by 18 million to 182 million, due primarily to higher costs for legal, consulting, and employment agencies tied to hiring, as well as an increase in travel and entertainment expenses.

Turning to the balance sheet, quarter end total assets were 94.5 billion, up from 93 billion at 9/30.

Our balance sheet size will fluctuate from quarter to quarter based on levels of market activity.

Higher market activity usually means security servicing clients will leave higher balance with us, and that's exactly what we saw this quarter as the balance sheet returned to a more normal level.

The TCE ratio improved to 5.57 percent at year end, up from 5.49 percent at September 30th, and remains comfortably above our 5.25 quarter target.

The tier one and total capital ratios also improved to 8.28 percent and 12.25 percent, respectively, up from 8.09 percent and 12.09 percent last quarter, and well ahead of our targets of 7.75 and 11.75.

With respect to Capital Management, we did not repurchase any shares this quarter or complete any material acquisitions.

The mark on the available for sale portfolio on a pretax basis was a positive 81 million at year end versus a positive of 150 million at September 30, and a positive 201 million at the beginning of the year.

With that, let me turn it over to Tom for some additional comments.

Okay.

Well, thank you, Bruce.

As I said earlier I am pleased to see how our business has responded to a more positive market environment for the quarter.

Our top line performance reflects the strength of the business model that we've built over the years.

We're well-positioned in all of our key product lines and well diversified with respect to products, customers, and geography.

In addition, the investments we have made over the last several years have resulted in a stronger and more durable franchise than at any other time in our history.

However, the legal and regulatory environment continues, certainly, to be challenging; and as a result, the cost of being in this business is higher.

And it's likely that our clients, certainly in the foreseeable future, will continue to be slower in making their business decisions as they are not necessarily forward-looking.

The costs associated with the height in the regulatory environment also puts greater pressure on our clients to shift their increased expense burden to us through tighter pricing; and while I believe this environment will eventually improve, it may be here for awhile.

That is why the breadth and the depth of our service offering is so important to us.

And that our focus and the success, I might add, in expanding market share has a multiplier effect when the market tone becomes firm as did it in the fourth quarter of this year -- of last year.

Our Analyst Presentation on January 25 will cover the following themes -- The diversity of our customer base, key growth opportunities domestically and internationally, our priorities and technology to fund future growth, a review of 2004 performance, and an overview of our 2005 priorities.

With respect to our earnings outlook for 2005, we believe that equity capital market conditions will continue to gradually improve over the year.

Fixed income markets should be stable to slightly off, and market volatility will be moderate.

This is an environment that should allow our operating businesses to post solid growth.

But I've got to add that our overall EPS growth rate will continue to be influenced by several corporate level items, including higher provision for credit losses, lower security gains, higher stock option and pension expense, and the bubble costs that are associated with opening a new out-of-region data center that will occur in 2005.

We look forward to seeing you next week to discuss all these topics in much greater detail.

And so we don't preempt next week's analyst meeting, I would appreciate if we could limit today's questions to our fourth quarter performance.

With that, let me open it up for some questions.

Terry?

Thank you. [Operator Instructions].

Brian Harvey, Fox-Pitt Kelton.

Thank you.

Good morning.

Good morning, Brian.

I just have a couple of questions.

The first one relates to expenses.

You indicated in your prepared comments that you were a little bit disappointed on the expense side.

Can you talk about some of the actions that you plan to take to address some of those concerns and return us back to positive operating leverage?

Well, I think some of the -- some of the things that took place in the fourth quarter are related really to fourth quarter activities, namely, increased performance and the incentive comp I think in particular.

We'll certainly see that go back to what I would call more normal levels of accrual as we enter into -- into '05.

I think the -- the issue of hiring, there's no question that we -- we saw a little bit of pent up demand in our headcount hiring requirements to support some of the increased business flow that we had during the course of the year.

And it's a fine balance between making sure that we control headcount and making sure we have enough staff to service the businesses we've got.

And we anticipated some of the increase after the election and did some hiring.

I think that is pretty well -- we're pretty well set.

We again, of course, in our '05 budgeting see more hiring; but we've been able to throttle that and we'll continue to throttle that during the course of the year, especially in the first quarter to make sure we -- we get off to a pretty good start.

Some of the other things that are impacting us, we're just going to have to -- to continue to live with through '05 such as the option expensing, increased pension costs, and this -- the new remote data center, which we will be opening at the end -- end of '05.

We're going to -- we're going to see that continue building up through '05, but then we will see some benefit in '06.

But, again, Brian, we'll talk a lot more detail about the '05.

We -- we will just be doing the blocking and tackling you would expect in terms of controlling our headcount, and making sure we get off to a fast start for the year.

Okay.

Can you quantify for us what those expenses could be and possibly what the -- what the offsets you could be looking at?

Are there further restructuring efforts underway?

I think we'll cover that in more detail next week at our analyst day, Brian.

Okay.

Thank you.

Thank you.

Next question, please?

Brian Bedell, Merrill Lynch.

Hi.

Good morning.

Thank you.

Hi, Brian.

Good morning.

Was there any unusual sort of true up in incentive compensation costs in the fourth quarter, or was that completely a function of the increased volumes?

Well, there's always a little bit of true up that takes place, Brian.

That's a -- that's a traditional fourth quarter effort on our part to just see where we are and what we need to -- to do to pay our people appropriately, given the nature of the year.

While much of it is incentive-based, there is a small portion that's always discretionary, based on how the overall organization does.

And so that certainly at a took place in the fourth quarter.

Beyond that, it was nothing more than a reflection of the increased activity after election day.

Okay.

And then can you quantify the expenses associated with the litigation outside of the 6 million that you mentioned, Bruce, for the RW?

And when I say litigation, I mean any other expenses associated with IRS litigation?

And also compliance and Sarbanes-Oxley and Basel II?

We typically don't break out that level of detail on the legal side, but suffice it to say that the cost of outside counsel as well as our own in-house legal staff continues to rise reflective of the environment; and that's something that we've seen probably going back over the past couple of years.

Right.

So aside from the RW lease[ph] thing and the IRS it's more of an ongoing issue?

I would say it's on -- it's -- at least for the moment it's ongoing, Brian.

I hope it's not -- we're not building this into our infrastructure cost, but --.

You become a legal firm?

Yes, exactly.

But I think we do have to work our way through -- through RW and to its -- to its conclusion and the SEC -- some of the SEC inquiries that we talked about in our Qs.

Those -- those we've got to just work their way through the process.

I think you raised a couple of other points, especially in Basel II and that has had an impact; and we, as being one of the required organizations -- organizations that are required to work -- to work within Basel II, we are well underway in terms of staffing up.

In fact, fully staffed our project management office to be prepared for Basel II, and that -- that was a -- that was really not -- that was a fourth quarter event.

It was really a last half event that we are now fully -- fully staffed in Basel II.

Those things will continue probably for another year until we -- we're all set and go live in '07.

Right.

Okay.

And then can you frame -- if not disclosing numbers but maybe just sort of a general comment on the magnitude of conversion costs for the new business and conversion for the RCM outsourcing baked into the fourth quarter, as well as Threadneedle?

Well, again, we're not -- we don't break out specifically.

The issues I think that confronted us in the quarter -- it wasn't necessary RCM Dresdner, because that had been something, Brian, that we really actually began in the latter part of '03 through -- throughout of '04.

It really is more Threadneedle and Insight.

Threadneedle in particular because that was -- not only -- it was outsourcing, but it was also essentially a lift out, meaning from our parlance a lift out of an existing activity that we did not have that we felt we needed to strategically to perform our services in Europe.

And with that came along, obviously, within the lift out environment its instantaneous increase in overheads, and I think that it almost -- it was close to 200 people.

That was a -- that was a focus of the increase in expense base from the outsourcing side.

And then in addition to the almost 200 people, we hired outside help to help with the conversion process of the systems interfaces between that new product in Swenden [ph] and the remainder of our systems infrastructure.

Right.

So the outside help is largely sort of one time-ish, assuming that you're mostly complete with the conversion and, then, of course, the 200 people that are ongoing, but this is ahead of revenue being recognized from Threadneedle?

Is that correct?

That's right.

There's some revenues in, but for the quarter there were more expenses than revenues it's safe to say.

Right.

Okay.

And then just lastly, your custody assets at 9.7 trillion.

The market would have indicated that it would have risen to around 9.3 trillion.

Do you want to just elaborate on the additional organic growth?

Well, that's exactly -- actually you got those numbers pretty well pegged, because it was about $400 million -- 400 billion, I should say in assets from new business, so organic growth and new business.

Okay.

Any major contracts you would want to --

No, it was -- it was pretty widespread.

I would say the nature of our -- it gives rise to maybe one comment that I ought to make and that is that our focus here in addition to some of these outsourcing deals really is to hit the singles, doubles, and triples here that really make up what I think is the core of our business, and that is -- that is very much of our intent.

So the nature of the new business that we got were those singles and doubles which very -- a very wide array of businesses that when you add up, comes up to some real money, like $400 billion.

And that's both out-right new business wins as well as doing more for existing customers.

That's also part of that growth.

Okay.

Great.

Thank you very much.

Thank you, Brian.

Next question, please.

Mike Mayo, Prudential.

Hi.

Hello, Mike.

I thought with only a modest increase in capital markets you might start to show positive operating leverage, and it sounds like there was some discretionary or non-permanent items in this quarter.

Can you quantify that?

Like, how much is that outside help to help you with Threadneedle?

And then separately, with all those additional expenses you're talking about, pension, stock options, data center, et cetera, might that stop you from getting positive operating leverage assuming cap markets continue to improve?

Well, we don't separate -- have not separated really the -- what I would call "the one timers" here, and we will be talking a bit more -- we'll be talking a good bit more on next Tuesday with regard to what we see as the so-called corporate level expenses that we've just got to deal with.

We're going to be looking at doing the -- doing a segmentation here, what truly are the true operating expenses associated with the -- with our expectations for '05.

So you can get a better sense of the operating leverage that does exist and then what other, as I described it, "boulders" we've got to carry, at least through the course of the next year.

So can you ballpark this quarter the increase in expenses, is like 10 percent temporary or half of its temporary, can you give some sense?

It's hard to say, Mike.

I mean, we target that we'd have at least 1 to 200 basis points here of operating leverage, and if you look at the growth , ex some of the specials it was kind of 6.6 versus 6.8.

It was basically flat.

And so you can kind of figure out that there were some influences inside the numbers that pushed the expense growth rate up to equal the revenue growth rate.

All right.

Thank you.

Thanks, Mike.

May I have the next question, please?

Thank you.

Gerard Cassidy, RBC Capital Markets.

Good morning, thank you.

Good morning, Gerard.

Can you guys share with us in the fourth quarter on your foreign exchange trading revenue some color?

Was there quite a bit of activity toward the end of the year, meaning December, versus October and November?

Or was it steady throughout the quarter?

I would say that the strongest month of the three was November.

And that carried through December.

Obviously the last week, Gerard, between Christmas and New Year's is a pretty slow week, so there's not quite as many full trading days, if you will, in December as there are in November.

So we really saw things build.

The dollar went on a slide which accelerated as the quarter went on, so there was more volatility, more trading, generally picked up after the elections here.

And there was a greater demand for hedging, given some of the movement in the currencies.

So we felt it was a pretty good quarter.

That said, we still weren't up to levels that we achieved earlier in the year, where the second quarter was really the high watermark for the year.

Great.

Tom, you mentioned in the opening remarks that your strong credit quality was the dividend for shareholders.

Obviously you had a negative provision.

But then you closed your remarks with the anticipation of higher provisions in '05.

You guys have such great reserves and we hear from some of your peers and competitors about pressure to bring reserve levels down.

I'm surprised that you guys still feel that you might have higher credit costs in '05 versus '04, considering how strong your reserve levels are?

Well, you know I would say notwithstanding the -- the approach that is being -- that we're being asked to take on, the approach of being very methodical, very precise, formulaic, almost in our provisioning, there still has to be some level of judgment associated with the -- with provisioning.

And so that's what leads us to at least conceptually view that -- cyclically, we are at a low point, Gerard, in terms of our credit costs.

And when you have a $30-odd billion loan portfolio and an NPA that will be less than $200 million, it's -- it is just not sustainable -- it's unsustainable at that level.

So we know we've -- we know that there will be a turn.

And my gut is that that turn will take place some time in '05.

It will be gradual where it will be a migration of criticizing classified loans first.

And yet, while we are not seeing that today, I know just given the nature of banking and lending and what I see -- the market -- the competitive marketplace today in terms of shrinking spreads, demand, the oversold condition in the secondary market, I know that will breed less -- less discipline.

When that takes place -- when it will be actually seen in credit costs, probably not until '06, '07.

But on the other hand, the provisioning has got to be to a certain extent in advance of that and -- in advance of that credit costs.

That's where the judgment comes in.

So my remarks in terms of -- that we'll see provisioning should increase in '05 it's in anticipation of the inevitable deterioration in overall credit quality.

Not necessarily that we're going to see a V.

It probably still will be bouncing along the bottom for awhile, and then we'll see a -- hopefully, a gradual decrease in quality and therefore the need for provisioning.

And our level of provisioning is strong but, again, we -- these are not necessarily normal times.

Not normal at the high point, and they're not normal at the bottom, and we are really at the bottom.

I appreciate your candor.

One final question on the deposits.

You mentioned that the higher rate environment in corporate customers are using compensating balances that pay for some of the fees that they need to pay you folks for the services you provide them.

If consensus is correct about that funds going up to 3 percent, excuse me, sometime mid-year this year, maybe 3.5 by the end of the year, I assume we should anticipate that that line item would continue to see lower revenue growth as more of your customers move to the compensating balance arrangement?

Yeah, I think that could be the case.

However, we do have organic growth in that business.

So I think -- I think that will be -- there were 2 moves during the quarter, and I think you saw in an excessive kind of flip over to the compensating balances than you might see on a sustainable basis.

So the 2, kind of, forces pulling in opposite directions.

We'll have our organic growth working to grow that fee category, but any further switches to the compensating balances would mitigate that to some degree.

Thank you very much.

Okay, Gerard.

Next question, please.

Ken Usdin, Banc of America Securities.

Thanks, good morning.

Good morning, Ken.

Two quick questions.

First of all, I wanted to just ask you about the asset management side of your inflows.

It had good growth in the assets under management again, but the fee side was a little bit lagging.

Can you talk us through that?

I would say it's a bit of a mix issue here, Ken, in that we saw some of the institutional equity products and short term money market products where the biggest drivers of the growth this quarter, and those tend to be lower fee contributors.

And throughout much of the year, we've had -- Ivy was pacing the growth and Ivy has kind of outsized fees relative to the rest of the portfolio.

So I would just attribute that more to the mix of the asset growth.

And the second question was on the securities gains this quarter of 18 million.

Can you just break that down?

Was that core, like MBS type of sales, or was that any type of BC or other portfolio holdings?

Again, most of that's on the equity side.

The fixed income gains that we triggered from repositioning were under 3 million of that total.

Thank you.

Ken, thank you.

Next question, please?

Ruchi Madan, Smith Barney.

Hi.

Good morning, Ruchi.

My question also about the expenses, specifically the salary and employee line being up 53 million.

Can you -- can you comment at all about how much the incentive comp related to higher business might have represented of that?

And is there any sort of rule of thumb that we can use as we think about how that line will vary with revenues?

And then I have a follow-up.

Bruce, do you want to break that out?

Well, I would say there was -- the incentive comp was a major driver there.

I don't think we can give you a rule of thumb on that because it depends really which businesses are generating the growth.

And they all have different compensation formulas.

Plus, as Tom indicated earlier, there is some true up involved.

There was hiring in the quarter.

Our overall -- from the acquisitions and lift outs we picked up about 225 people across our, kind of, growth businesses.

We hired 325 people.

And then some of the cost initiatives that we had that are ongoing in our reengineering efforts dropped out about 225 people.

So net/net there was headcount growth that added to the salary and benefit increase, and then as we discussed outside help and overtime related to these conversions and some of these technology projects to position us for growth for next year, that also contributed.

I think, Ruchi, if I can talk for one -- a little more color, in terms of -- in terms of the increase in our expense rate for salaries and benefits, I would say the -- they're all fairly balanced.

But the 4 principal portions of it was outside help and overtime associated with some of the conversions of, again, some of the outsourcing wins.

Probably next would be pension cost, option expensing.

Next would be the true up in terms of performance-related fees.

And then some new hires.

So I think it's a combination of all those 4 items that were -- they're fairly well-balanced.

So there was already an increase in option and pension expense reflected in this quarter?

No, the amount --

For the year.

Oh, for the year.

For the year.

Okay.

And then also just want to ask, as you think about your pipeline to add new business, specifically outsourcing business, that does require up front expenses, how does that pipeline look?

And do you think that is going to have a meaningful impact on how we think about expense growth next year?

Well, that's a good question, and one that we're really wrestling with right now, Ruchi, in terms of how we approach '05.

I would say that the pipeline -- the level of discussions that we're having is still very healthy.

And I would have to say more than we're prepared to take on.

So I don't think that there's -- there's not an absence of opportunity.

The question in our minds that we're wrestling with is which ones do we want to take and have -- and be able to -- to be as selective as we possibly can in taking on these outsourcing requirements -- outsourcing opportunities.

As I said earlier, I think it was to Brian Bedell, that I think our tactics here is to -- not to forget about, in fact to even more emphasize those bread and butter wins that we have for our basic custody -- global custody businesses here.

And that is where we are focusing attention on.

So we want to make sure that there is, in fact, a balance where we continue to generate good, solid growth in -- organic growth through new business wins and balance that appropriately with some of these major outsourcing wins that are not only important from a topline, but they're also equally important tactically in terms of being able to serve our overall client base.

And that's why Threadneedle was important to us, and we are committed to that because it added something that we needed tactically.

Now we've got to work through the economics of it to make sure that it is as beneficial as we possibly can make it as early as we can make it.

Okay.

So we should not think about this in terms of you see a big opportunity and you're willing to sacrifice your operating leverage targets to go after that opportunity or anything like that?

That's not a driver for us, no.

Could it happen that somebody comes to us?

I can't -- I can't answer that unequivocally, Ruchi.

I'm -- all I can say is conceptually and strategically we are not -- we are not driven by the top line growth that could be associated with an outsourcing contract if there's the risk that it's all assumed or subsumed by the expense increase.

Okay.

Thanks.

Next question, please.

Robert Lee, Keefe Bruyette and Woods.

Thank you.

Good morning.

Good morning.

Quick question on capital management.

I'm just curious.

Capital levels continue to build.

Didn't do any real meaningful acquisitions in the fourth quarter.

Could you just give us some comment on -- I guess I would have expected at least a modest level of share repurchase and maybe a little bit of sense of where your thoughts are of that at this point.

Sure.

You know, I think the acquisition pipeline has picked up and so we do have numerous conversations at the moment.

It remains to be seen if those are productive and end up in transactions.

So I think that was one of the things that we factored into stopping the repurchase activity during the quarter.

The other thing that we had in mind was that the markets really picked up after the election, and we can have an incredible amount of volatility in the size of our balance sheet.

The fulcrum has been around 95, 96, but we can hit 100 and we can go all the way down to 92.

And so we felt that it was a reasonable possibility that we could end up with an elevated balance sheet at year end.

So given really those 2 factors, we decided to build the capital ratios and see how it played out.

So at this point, we end up with a very handsome capital ratio at year end.

But clearly we'll be addressing our capital management priorities in the analyst meeting on Tuesday.

I'm -- I'm never in a position to say we have too much capital.

And it's a -- given the inherent volatility of our balance sheet, we made a calculated decision.

It turned out very much in our favor.

We ended up with some good capital ratios.

But we have opportunities, we feel, to use that capital to the benefit of our are shareholders, and we'll do that.

Other questions, Rob?

That's it.

Thank you.

Thank you, Rob.

Next question, please.

Kim Foley [ph], Columbia Management.

Kim?

Good morning.

Good morning.

I was wondering if you could give me a little bit more color on the private client business.

I thought you would get a little bit more leverage with the markets up, and just the private client asset management line was relatively flat quarter-on-quarter.

Maybe just give me a little bit more on that, please?

Well, I think it's, again maybe what -- as Bruce indicated earlier, it's more of a mix shift than anything.

Certainly the other parameters -- the other major parameters of assets under management I think grew nicely in reflection of the markets and much more -- we are much more -- we are more active with regard to the institutional business as well as the money management business, and I think that's -- that's really the -- more of the -- the performance is more a reflection of that business mix rather than any cost issues surrounding that business.

That was not the case here.

I think it's a matter of fee realization.

Okay.

Thank you.

I think there's also a -- sometimes a lag in some of the pure private business in terms of the pricing effect of a bump up in the S&P.

So that should carry over into the first quarter.

May I have the last question?

One more question, please, Terry.

Thank you.

Mike Mayo, Prudential.

Hi, again.

Hi, Mike.

I know your intentions were good in terms of highlighting additional expenses next year for -- or this year now, pension, stock option, data center, et cetera.

But since you made that statement the stock's gone down 5 percent, I guess you lost over $1 billion of market cap because of the uncertainty, and I feel like I'm hanging out here, I'm not sure what I'm supposed to do with that new information.

So as a follow up to Ruchi's question, which of these expenses are at least partly in the fourth quarter, and which might be new, or do we just have to wait and have this uncertainty hanging over us until next Tuesday?

Well, that's an interesting question.

Obviously in a perfect world I'd like to -- I'd like us to wait until Tuesday to give an expansive -- a much more expansive view of it, and I think that would be the appropriate thing to do.

The view here, though, is not necessarily that there is additional expenses that we haven't -- we haven't highlighted or tried to signal during the course of the year.

I don't anticipate there be anything new in '06 -- '05, rather, that we haven't experienced in '04.

So from that point of view, there is nothing new in what we're saying here.

It is more a matter of -- to make sure that people understand these are the issues that we're -- we're wrestling with, and not unlike any other organization.

So it's a matter of -- you've -- they've already been there, it's just the magnitude is going to go up to some degree?

There's two things if you parse the thing that Tom said will affect next year.

Mike, one is to make sure you're looking at the sustainable level of the provision.

One is that the set gains this year were higher than we had guided and that we don't think they're at stainable levels at what they were in '04, so you might expect those would come down in '05.

And that the pension and option expenses are an ongoing cost pressure that we have to deal with, and the new data center is something that we have been candid about throughout our discussions this year, that that will have a cost impact on next year.

You know, I think, Mike, the point here that we are trying to make -- that I'm trying to make is that we had a very fine fourth quarter.

I think it was very much reflective of the marketplace as one would expect.

Operating leverage within, after the -- after these corporate overhead, corporate level issues that we've got to cover, I think it was quite good, and I expect that it will be quite good in '05.

I'm optimistic about the market environment.

I don't think this company has a topline issue whatsoever, and our view is to make more of that topline growth come to the bottom line.

That is, has been, and will continue to be our goal.

So we are not trying to signal anything beyond that fashion.

Do not necessarily -- as I think people were prone to in the early part of last year, take that topline growth and expect all of it to flow to the bottom line.

I'm trying to be as cautious as I can, but yet, maintain the view that the business model works exceptionally well. and we're going to show some growth.

All right.

Okay.

So -- we will wait until Tuesday then for the rest.

Last chance to ballpark this impact of these 4 items.

Is it we're talking a nickel, a dime, $.015, $0.30, a range?

I've already got like 5 calls in the last 20 minutes.

I think it's best to wait.

I'm not prepared to talk about that on the phone like this.

Okay.

Fair enough.

Thank you.

Okay, Mike.

Okay.

Well, thank you.

That concludes our fourth quarter earnings call.

We certainly appreciate everybody joining us and with any other questions regarding our fourth quarter, please contact Joe -- Joe Murphy in our Investor Relations area.

Thank you for our interest.

Good day.