紐約梅隆銀行 (BK) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Mellon Financial second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mr. Steve Lackey.

Mr. Lackey, you may begin, sir.

Thanks.

And welcome and good morning.

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, distorted, broadcast, disseminated, published, sold or otherwise used for public or commercial purposes without the express written consent of Mellon and the relevant information providers.

The archived version of this conference call and the earnings summary will be available on our Website mellon.com until Wednesday, August 2, 2006 at 5:00 p.m.

Eastern Daylight Time.

In addition, the archived version of this call may be available -- will be available via podcast.

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, 2005, as well as page one of our earnings summary report.

These forward-looking statements speak only as of July 19, 2006.

And Mellon Financial undertakes no obligation to update any forward-looking statements to reflect events or circumstances after of that date or to reflect the occurrence of unanticipated events.

Participating in this morning's call are Bob Kelly, Mellon's Chairman, President and Chief Executive Officer;

Steve Elliott, Mellon's Senior Vice President; and Mike Bryson, Mellon's Chief Financial Officer.

In addition, a number of Mellon's executive management team is available to respond to questions, including Ron O'Hanley, Dave Lamere, Jim Palermo, Jeff Klinck and Bob Stasik.

Please note that Mike Bryson's review of the financial results during this call will follow the format of the earnings summary report that is currently available on the home page at mellon.com.

Now, I'd like to turn the call over to Bob Kelly for opening remarks.

Good morning, everyone, and thank you for joining the call.

We're pleased with our 12% growth and continuing EPS of $0.55 per share.

Excluding large one-time, extraordinary gains in prior years, this is a record for us.

Our results were driven by a strong top line grown particularly in Mellon asset management and asset servicing.

In the second quarter, these two businesses generated combined revenue growth of 27% and pretax income growth of 43% and both of these businesses generated higher margins.

Now, based on strong new business generation, we ended another quarter with record levels in assets under management and assets under custody.

Our assets under management were $870 billion at the end of the quarter and they grew 18% year-over-year.

They included strong organic growth during the quarter of $17 billion in net new flows.

Plus $47 billion in assets under management associated with the WestLB joint venture that closed in the beginning of the quarter.

Now, just as a reminder the Walter Scott transaction closed as early in the fourth quarter and is expected to be accretive to earnings.

In looking at assets under custody, they are $4.2 trillion, grew 22% year-over-year, and they included net conversions of new business totaling $45 billion during the quarter.

We continue to benefit from strong synergies between asset management and asset servicing.

During the second quarter, asset servicing clients provided our institutional asset managers with 39 new mandates, ranging from active asset management to transition management.

Over the first month -- over the last month or so, we also announced the opening of two rep offices in China, one for Mellon Financial and one for our ABN AMRO Mellon JV.

And by the way, during the quarter, 2/3 of new business involved asset management and asset servicing originated outside of north America.

Mellon asset management, private wealth management and asset servicing now represent 93% of total pretax earnings.

Mellon asset management represented almost 50% of the corporation's pretax earnings, which grew 45% year-over-year.

Asset servicing represented 25% of the corporation's pretax earnings and grew 40% year-over-year.

And as you know, we continue to make sizable but stable investments in private wealth management.

Our investment management fee revenue increased 15% in that business.

But growth initiatives and slightly lower net interest revenue resulted in a slight decline in pretax profits in that segment.

Our EPS benefited from a lower tax rate as well.

The difference between our actual tax rate and our expected tax rate related to a benefit of 10 million or approximately $0.02 per share in connection with the completion of a recent IRS audit cycle.

However, our results in the second quarter of 2005 included several unusual gains worth about $0.03 per share.

Specifically, there is a discrete tax benefit of $0.01 per share plus $0.02 from a lease transaction.

So year-over-year, our results were fairly consistent on any way you want to look at it.

Our ROE, at 42%, remains excellent.

Our pretax margin of 26%, although unchanged from the first quarter, declined slightly compared to last year's 27% due to lower net interest revenue and expense growth that frankly remains too high.

Staff expenses, while controlled giving growth associated with Mellon Asset Management and asset servicing, the management team and I continue to believe that there are very good opportunities for improvement in many of our expense categories.

And we are studying these intensely.

We are currently midway through our strategic planning process, which is focused on continuing the strong top line growth that Mellon has been generating, while expanding the margins of our business.

Particularly, Mellon asset management, asset servicing and payment solutions and investor services.

The analysis results and recommendations will be reviewed with our Board in October and we're planning an investor meeting on November 13 in New York.

I look forward to representing and presenting the specifics on our plan for continuing top line growth while expanding our pretax margins.

At this point, Mike will be available to provide further detail on the quarter.

And then as we indicated earlier, we'll open up the session for Q&A.

Thank you.

Thank you, Bob.

As Steve Lackey noted, my comments will focus on our quarterly earnings summary report, highlighting the key numbers and metrics that we have boxed on each page.

And I will start with the financial highlights on page two.

Strong growth in our assets management and asset servicing businesses resulted in continuing operations EPS of $0.55 per share, an increase of 12% compared to the second quarter of 2005.

Earnings per share for the total corporation, which includes discontinued operations, totaled $0.56 in the second quarter compared to $0.30 in the prior year quarter, which was impacted by the sale of our HR business.

Mellon asset management, private wealth management and asset servicing, as Bob noted, accounted for 93% of our income before taxes.

And I will detail the performance of all of our businesses shortly.

As Bob also noted, we ended the quarter with a record level of assets under management of $870 billion and a record level of assets under custody or administration of $4.2 trillion.

Key revenue growth of 18% was in line with expense growth.

However, growth in total revenue was below the growth of total expense due primarily to a lower level of net interest revenue, reflecting the challenging interest rate environment, as well as higher distribution, expenses and the impact of our growth initiatives.

Our capital ratios were at the top end of our targeted range, in spite of higher unrealized losses in our available for sale securities portfolio and a quarter end balance sheet surge and continued share repurchases.

I would like to skip over page three, as it really just details some information that I've already cited, and move to page four for a discussion of noninterest revenues.

As noted earlier, fee revenue grow 18% year over year, driven by a combination of new business generation, higher performance fees, improved capital markets and strong growth in our asset servicing joint ventures.

Let's take a look at the details.

We generated 21% growth in investment management fees, with approximately 25% of that growth driven by an 86% increase in performance fees.

The growth was primarily organic, as the S&P was only up 7% year-over-year and only about 35% of our assets under management are comprised of equities.

I would also note that investment management revenue, excluding the impact of performance fees, increased 5% unannualized on a linked quarter basis.

Distribution fees grew 45%.

But of note, is that approximately 75% of that growth was from Mellon Global Investments, our international distributor, consistent with our strategy to expand our asset management franchise outside of the United States.

Investment trust and custody fees were up 26% year-over-year. 19% excluding the impact of last year's acquisition of Mellon Analytical Solutions.

Driving the increase was the impact approximately 350 billion of net new business conversions over the past 12 months, higher earnings from the ABN AMRO Mellon and CIBC Mellon joint ventures, and a 12% increase in securities lending revenue.

Payment solutions and investor services fees were down 12% year-over-year.

The decline was due to lost business as well as more customers paying with deposit balances in lieu of fees.

I would point out that payment solutions and investors' solutions services fees increased 4% unannualized, on a linked quarter basis.

Foreign exchange trading revenue reached a record level of 35% year-over-year, reflecting increased volumes and higher volatility.

I would remind you, however, that securities lending revenue, which is included in institutional trust and custody fees, is expected to be seasonally lower in the third quarter of 2006 due to the end of the international dividend arbitrage season.

Now, I'd like to turn to page five.

Net interest revenue declined 8%, despite an 11% increase in average earning assets.

I would note that the second quarter of 2005 included a $12 million benefit from a client's extension of a leveraged lease transaction.

So excluding the impact of that lease, net interest revenue was essentially flat.

Over the last 12 months, the increase in both the level and yield of our floating rate investment securities portfolio more than offset the spread compression on the fixed and adjustable rate portions of that portfolio due to the higher cost of client deposits.

But that benefit was negated by a 10% decline in average loans, principally large corporate real estate loans and leases.

Recall that we exited the large corporate real estate loan business in the first quarter of this year.

Compared to the first quarter, net interest revenue declined 6% unannualized.

Primarily due to the sale of the large corporate real estate loan portfolio and funding costs related to a higher level of seed capital investments and the investment in the WestLB Mellon joint venture.

Again, we had spread compression in the investment securities portfolio, due to a lower proportion of noninterest-bearing deposits supporting investment securities but that was offset by investment portfolio growth.

Turning to our outlook for the third quarter.

Net interest revenue on a fully taxable equivalent basis is expected to be in the range of $122 million to $127 million.

The biggest variable in that range is the average level of noninterest bearing deposits we have in our processing business.

Primarily, working capital solutions and Mellon investor services.

For additional details on our net interest revenue and margins, please refer to pages four and five of the appendix to this report for a 10 quarter trend of average balances and interest rates and yields.

Turning to expenses on page six.

I'd like to detail the variances in both staff and nonstaff components of operating expense.

First, looking at staff expense.

The compensation component of staff expense remains well controlled.

Excluding acquisitions and the impact of severance, compensation increased only 4% year-over-year versus much higher revenue growth.

Compensation was virtually flat on a linked quarter basis.

The growth in incentives was principally due to the growth of pretax profits in Mellon asset management and asset servicing, each of which were up over 40% in pretax income.

Benefits were up year-over-year as the result of increased pension costs and the acquisition of Mellon Analytical Solutions.

Turning to nonstaff expenses, professional, legal, and purchase services expenses were up due to both new business generation and the support of our strategic growth initiatives.

The increase in distribution and servicing expense, which is largely offset in revenue primarily, relates to higher mutual fund sales outside of the United States.

Net occupancy and equipment expense remained well controlled.

And the increase in other expense related principally to the growth of our joint ventures and the associated amounts of past due revenue, which we record as other expense.

As you model expenses, I would remind you that our annual merit increase was effective the first of July.

This will increase compensation by approximately $8 million for the third quarter or 3% on an annualized basis.

There will also be a smaller corresponding increase to benefits expense in the third quarter of approximately $1 million to $2 million.

Our overall expense growth represents an opportunity for improvement.

As Bob noted in his opening remarks, our management team is currently completing a strategic review of our business portfolio with a focus on continuing top line growth while expanding margins.

Turning to page seven, our second quarter results continue to demonstrate the core strength of our focus on asset management and asset servicing.

As these businesses represented 82% of our revenue and 93% of of pretax income, both records.

The key driver of the success in asset management is continued strong net asset flows, which totaled $49 billion over the past 12 months and $17 billion in the second quarter.

As shown in this table, the 17 billion of flows for the second quarter of 2006 were comprised of 11 billion of long term and 10 billion of money market inflows, partially offset by $4 billion of securities lending outflows.

Turning to page eight.

I really will not spend any time on page 8 but rather look at each sector individually on the next four pages, beginning on page nine.

Mellon asset management had another exceptional quarter.

With 24% growth in revenue, driven by;

Strong flows, including 21 billion in the second quarter of 2006.

Improved equity markets.

Higher performance fees, approximately 26% of which were from new clients.

As well as the impact of the WestLB Mellon joint venture.

Along with 7 points of positive operating leverage to drive Mellon asset management's pretax operating margin from 24% to 26% and 45% growth in pretax income.

I would note that the adjusted pretax margin for Mellon Asset Management excluding distribution fees and expenses, was 36% in the second quarter of '06, compared to 30% in the prior year quarter.

The acquisition of Walter Scott and Partners, with 27 billion in global equity assets, is expected to close early in the fourth quarter.

Turning to private wealth management on page 10.

Total fee revenue increased 14%, driven by organic growth and new business, improved equity markets and the acquisition of City Capital and the Planned Giving Services group of U.S. Trust.

On the banking site, private wealth management experienced a 2% decline in net interest revenue, despite a 7% increase in average deposit levels.

This sector has the highest concentration of core MMDA deposits, which, given their stability, have traditionally exhibited lower repricing sensitivity.

Over the past 12 months, however, the costs of these client deposits have increased faster than the rates earned on the investment portfolio securities in which they were invested.

The year-over-year expense growth of 14% reflects the impact of the growth initiatives that began in the second half of 2005.

To date, these initiatives have opened -- have included opening two new offices in Florida, additions to our U.S. sales force, increased marketing efforts and enhancements to our technology platform.

It is worth noting that we've been able to make these growth investments and still maintain an industry leading margin of 41%.

Turning to page 11.

Asset servicing also continued its strong momentum in the quarter with a 33% increase in revenue and 2 percentage points of positive operating leverage, resulting in 1% of margin expansion and 40% growth in pretax income.

Fee revenue growth included strong increases in institutional trust and custody fees of 34% and record levels of foreign exchange and securities lending revenues.

The increase in net interest revenue was driven by higher foreign and domestic deposit balances, which by their nature are invested in short-term and floating rate securities.

Asset servicing continues to be recognized for top-rated service quality, as we remained the Number 1 rated Global Custodian among our peer group in the Global Investor Magazine Customer Survey.

A ranking we have achieved in four out of the last five years.

Turning to page 12.

The second quarter of 2006 represents the fourth consecutive quarter of stable to improving results for payment solutions and investor services.

Although results included the benefit of some seasonality associated with the annual meeting season, we believe that we've established a good foundation for future performance.

Net interest revenue has been increasing over the past year, as higher interest rates have increased the level of clients paying for services via deposits in lieu of fees.

An 11% decline in fee revenue was substantially offset by a 30% increase in net interest revenue.

Overall, expenses remained well controlled.

Since the second quarter of 2005, total head count in this sector has been reduced by 300.

The pretax margin of 23% and return on equity of 41% remains strong.

As another recognize of our focus on service quality, on May 5, Mellon investor services was awarded the J.D.

Power Call Center Certification for their facilities in New Jersey and Manila.

Turning to page 13.

Looking at the other sector, we reported a pretax loss of 17 million in other activities in the second quarter of '06, compared to pretax income of 25 million in the prior year quarter.

The decline reflects, among other things, a decline in net interest revenue due to the $12 million impact from a client's extension of a leveraged lease in the second quarter of 2005.

Lower net interest revenue reflecting the higher cost of interest-sensitive funds purchased by corporate treasury from our business sectors, which are supporting primarily adjustable rate securities.

And a decrease of 14 million in corporate owned life insurance revenue.

Offset in part, by higher net gains in investor capital and a credit of $3 million for the provisions for credit losses in the second quarter of '06.

Finally, I'd like to take a moment to discuss the potential redemption of our Series A and Series B junior subordinated debentures, which are callable in December of 2006 and January of 2007 respectively.

From a capital management perspective, redemption of the debentures is expected to reduce our funding costs beginning in 2007.

We anticipate replacing these securities with a combination of Tier I qualifying securities and senior debt.

If these redemptions were to occur at the earliest call, we would expect a charge to income of approximately $21 million for the Series A and $23 million for the Series B debentures.

Primarily related to redemption premiums and unamortized issuance costs.

As Bob noted earlier, we are midway through the process of completing our strategic review and look forward to meeting with you in November.

Operator, we would now like to open the lines for questions and answers.

Thank you, we will now begin the question and answer session. [OPERATOR INSTRUCTIONS] The first question is from Brian Bedell from Merrill lynch.

Please state your question.

Good morning, guys.

Just following on Mike's -- just past comments on the potential charges.

Those would be in the fourth quarter for subordinated debentures?

Brian, I think they would either be in the fourth quarter or the first quarter.

And that kind of all depends, from an accounting perspective, on both when we would actually call the issues and/or when we would actually redeem them.

But assuming we did it at the earliest date, it would -- they would be in the fourth quarter potentially all of them but either fourth quarter, first quarter.

There's some accounting issues that we would need to research.

Right.

So, a mix of both.

What -- are these pretax charges or aftertax?

Those are pretax.

Okay, great.

And then just on some of the business trends.

First of all, in asset management, the 11 billion of long-term inflows, can you break that out between equity and bond and say whether it's institutional and/or mutual fund?

Brian, this is Ron O'Hanley.

How are you?

The way I break it out is first geographically, almost -- over 2/3 of it would be non-U.S.

And the products were heavily oriented towards asset allocation, alternatives, both fixed and equity based alternatives in international core.

A rough breakout of that would be probably 60/40 equity or equity-like -- 60% equity or equity-like, 40% fixed income.

And with, in terms of it being institutional versus retail, I would break that up out about 50/50 also.

And when you say retail, that would be non-U.S. retail?

Yes, I'm counting both retail U.S. and retail non-U.S.

Inventory is retail non-U.S.

Right, great.

And while we're on that subject, performance, I think you said -- either Bob or Mike Bryson said, 26 million of performance fees were generated from new clients, is that right?

26%

26% Right.

26% from clients that we didn't have 12 months ago.

Right.

Which goes back to the point that we tried to make repeatedly, that our performance fee growth is a function of not just investment performance but just overall client growth, too.

Great.

And that you're attaching more the -- or you're creating these structures that have more performance fees -- or these mandates to have a higher performance fee structure to them.

Right.

And then just lastly in payment solutions, are you comfortable of maintaining that margin or near the 23% area going forward?

Yes, this is Bob Stasik.

We have initiatives in place that we believe we'll be able to maintain those margins going forward, a reasonable pipeline and initiatives underway to support the continuing trends that we've experienced over the last four quarters.

Can I ask one more question?

Sure.

So, just for Bob.

In terms of your strategic review, I know you're still in the midst of doing that.

But is there any low-hanging fruit in terms of expenses that could impact the third and fourth quarters?

I'd say it's a little early to say at this point.

We're deep in the heart of it right now, Brian.

And so, I'm going to hold off on that and we'll talk about it later in the year.

Great.

Okay?

Just a couple of things I'd add to the comments that you have, the questions that you had.

Just on the subordinated debt that we talked about a couple of minutes ago, that of course is pretty expensive debt.

And so if we call that and then reissue, there will be good benefits in that in future years, obviously, next year and beyond.

And on the PS and IS in the payment solutions businesses, if you look at the trends for the last six quarters or so, certainly the last five quarters, there was quite a dip from the second quarter to the third quarter of last year when we lost some business.

So, if you just look at third quarter last year and beyond, actually Bob's done a pretty good job of building that business for the last four quarters in a row.

The next question is from Glenn Schorr from UBS.

Please state your question.

It's actually Debbie Altman in for Glenn.

Quick question on the balance sheet and the net interest margin.

With the corporate real estate loans fully off the average balance sheet now going forward, is the mid-1.7 range a good way to think about the NAM?

It's Mike Bryson, Debbie.

I think we can -- as we go forward, I think we will do a little better than that.

One of the things that we expect to do is, given that we've moved sort of out of that large corporate commercial real estate loan market, we do have a pretty big emphasis on growing loans outside of the wealth management area.

And I think those loans are going to have better spreads than investment securities.

So, that should benefit the net interest margin.

The other factor that, all else being equal, will benefit it is that a lot of the compression that we've had has really been around some adjustable rate mortgage securities that we began buying about three years ago.

We stopped buying fixed rate and started buying adjustable rate and floating rate.

And we're going to see those securities begin to adjust or reprice here in the third quarter and fourth quarter.

And that will -- the rates will either adjust up or they will prepay and we will invest at higher yields.

And then the other factor, which as I did mention is a little bit of a wild card but it really impacts that net interest margin, is the level of noninterest-bearing demand deposits that we have in our processing businesses.

So, that's a little bit of a wild card each quarter.

But the other factors, I think, would serve to improve the net interest margin as we go forward.

Okay.

That's helpful, thanks.

And just one quick follow-up.

Is there any way to quantify the impact of WestLB on investment management fees in the quarter, just a ballpark idea?

Yes, it was insignificant.

The WestLB has been accretive for us certainly right from out of the gates and was accretive in the first quarter.

But in terms of new business and impact, you wouldn't have seen much of an impact.

Remember, Debbie, that we account for these 50/50 joint ventures on the equity accounting method.

All that is in revenue is the aftertax earnings of the joint venture.

So, it's very similar to our asset servicing joint ventures.

Probably one of the things that, just as we do with the asset servicing joint ventures, we made them to begin to do going forward, as we have separate disclosure in our Q of the total revenues that are experienced in those joint ventures themselves.

So, you can get an idea of how they are growing.

This is Ron again.

What you will start to see through the balance of the year and certainly to next year, is the effect of what we'll call cross sell.

And we've already closed three institutional assignments for our institutional investment subsidiaries that refer to us from the joint venture.

There's a pretty strong pipeline.

So, you'll see that grow over time.

But certainly for the second quarter, that wouldn't have shown up much in the numbers.

That's helpful, thanks.

The next question is from Mark Fitzgibbon with Sandler O'Neill.

Please go ahead.

Good morning, gentlemen.

I'm wondering Bob, given expense saving opportunities you've mentioned, whether you think it will be achievable to achieve positive operating leverage during the back end of this year?

As I indicated earlier, I think it's early to say that, Mark.

And quite frankly, we're all quite convinced that there's going to be good savings here.

But it's not going to happen overnight.

It's going to take a year or two to get to the level of margins that we think our Company should have, both in total and by business line.

So, we are doing a very detailed analysis, not just of each of our expense lines but just looking at each of our businesses and is saying, "okay, what's our margin of the business?

How does it look going forward for the next couple of years and how does it look versus peers?"

And I indicated in the call in the last quarter that our goal is to have margins at least at the median or the average of our peers in each one of our business lines and therefore, in total.

So, it's pretty clear that in our largest businesses, excluding Dave Lamere's business in private wealth management, there are good opportunities.

And we're not just looking into businesses, we're also looking at the staff areas and head office as well.

So the short answer on this is; you're going to have to give us a little bit of time but we'll lay it out in more detail in terms of what our goals would be and what we hope to achieve over the next year or two when we get together in November.

The second question I had, I'm curious how well you'd be willing to take your tangible capital ratio?

And in that same vein, are buybacks likely to follow the same sort of schedule that we've seen in years past where their activity is strongest in the first and fourth quarters?

Mark, it's Mike.

Let me answer the tangible capital question.

As I think you've seen from a number of other players out there in the marketplace, one has to ask how important a measure that really is going forward.

And part of that is really around what we hinted at was, if we replace our junior subordinated debentures and use some hybrid capital securities, they don't represent common equity but both regulators and agencies give you full equity -- credit for it.

So, I think the way I would answer the question is to say that we will maintain our capital ratios as the regulators and the rating agencies sort of see them.

That could result in a slightly lower tangible capital ratio.

But it's only because of the nature of the instruments that you're sort of using.

So, I think we do need to keep our capital ratios in the eyes of those key constituents reasonably strong.

I would echo that as well, Mark.

We want to have a strong balance sheet.

And then your second question, Mark, I sort of missed.

Was that on --?

On the buybacks, are we likely to see the same kind of trends that we've seen in years past?

I think it's probably, premature to talk about 2007 here.

I think we're -- the guidance that we've given you for 2006, which goes all the way back to our investor conference of last year, that except for some equity that may be issued in the Walter Scott transaction, which will be accretive, we'll probably be around the top end of that fully diluted share guidance that we provided for 2006.

And that was about 411 million shares.

But as I said, there will be some shares issued in Walter Scott and that will be late in the year.

So, they will move our share count up.

But as I said, I think it's a little premature to look at 2007 here, because of some of the refinancing we will need to do and potential impact for acquisitions and things like that.

So, I think you'll see -- we'll give you some guidance on that when we see you in November.

But for this year, I think you can work with the guidance that we put out there.

Thank you.

The next question is from Robert Lee from KBW.

Please go ahead.

Thank you, good morning, everyone.

I just had a question on asset management.

And understanding that you're going through a strategic review in depth and a lot of things you're looking at.

It seems like a lot of the momentum clearly in asset management is from outside of the U.S. and also in the retail.

And maybe this isn't a fair comment.

But my perception is that to some degree, Dreyfus has probably seemed to have some issues in the mutual fund business getting as much traction as maybe you would have liked.

At least that's my perception.

When you look at -- think of your acquisition strategy, the Walter Scott's, where you buy a -- you have a bolt-on acquisition, do you have any thoughts that you need to do something in the U.S. and the retail space to maybe beef up Dreyfus some more or do something to help accelerate your penetration of the U.S. retail market?

Well, this is Ron, Rob.

I think that your perception of Dreyfus is accurate and that's our perception, also.

And we're spending a lot of time on that.

I think you know, we've moved a lot of the actual money management from Dreyfus to our respective institutional asset management subsidiaries to bring the power and strength of the institutional asset management capabilities to the retail market.

That is starting to show up in the weighted average investment performance numbers that grew from the first quarter to the second.

In terms of new products, we've got several new products that were launched toward the end of the second quarter and more coming in the third quarter that are aimed right for that retail market in the U.S.

So, it's very important to us to have a strong U.S. retail business and we intend to build one out there.

And we see the momentum starting to turn in Dreyfus.

Might I add to that Robert, it's Bob.

We wouldn't exclude acquisitions in the retail space in the U.S. but it would have to be financially and strategically pretty compelling.

When you really look at our history over the past few quarters of where we're investing in, most of it has been offshore.

When you think about the Walter Scott's and the opening of our JV's in China, where I'm sure both our asset servicing and our asset management businesses will see nice growth over the next few years, clearly we're a business that continues to globalize.

But having said that, we do recognize we have challenges here, which here in retail and north America and the U.S.

I feel pretty comfortable and confident that Ron and his team and our specialists will be able to organically be able to fix some of the product holes we have and improve our intermediary distribution.

On the acquisition side, we'll just have to see.

And so having said that, it would be -- prices are tough and we'll just have to see how the market develops and time develops over future quarters.

Right, if it's okay, I have a follow-up question?

Sure.

In both asset management and asset servicing, could you talk a little bit about the pipelines you see?

As you're looking at asset management, is there a decent pipeline of unfunded institutional wins?

And a similar question for the asset servicing business.

Well, this is Ron.

Why don't I start?

In terms of asset management, we had a lot of fundings occur in the second quarter but the pipeline won continues to be strong.

And, yes, there is a fair amount of won but unfunded business out there that we'll fund in the third quarter.

The way I would address that question is;

We continue to see strong growth outside the U.S.

We continue to see strong growth in our core U.S. institutional business.

And would I describe the pipelines as actually outpacing the sales growth at this point.

The pipelines are building faster than sales are.

I'm sorry, just a quick follow-up to that, I apologize.

Are you seeing any benefit from the big acquisitions at Blackrock and [Legded] and maybe some people starting to look for third-party, other managers who haven't been involved in big transactions?

Not really.

We haven't seen certainly any pick up in the number of mandates being put out and it's about average.

But what we are seeing for ourselves is that we're winning a higher percentage of what we go to bat at.

And on the asset servicing side -- it's Jim.

To break it down between the U.S. and then internationally, if you take a look at the pipeline last year at this time in the U.S., we're looking at about 80 deals that we were competing on representing about 1 trillion in assets.

Today, that pipeline is about 100 deals and about 1.5 trillion in assets.

So, I would call it more robust than a year ago.

Although, I would say that we are seeing decisions being made a little more slowly this year at this time than we were last year.

When you move overseas and looking at the international side, I would characterize the pipeline just as Ron said, it's quite robust.

We've got over 50 deals we're looking at, representing about 285 to 300 billion in assets at the moment.

So, things look pretty good on that side.

The next question is from Rob Rutschow from Prudential.

Please go ahead.

Good morning.

I was just wondering -- and I apologize if the you've answered this already, but in terms of the investment securities portfolio, it looks like there's some repositioning going on there.

Is that going to continue?

What would be your expectations going forward?

You're right, Rob.

It's Mike.

We have -- if you go back and look at the trends that are in the appendix to our report, you will see that we have materially increased the percentage of floating rate mortgage back securities in the portfolio.

Where a year ago they may have been about a 1/3 of the portfolio, they're now almost half of the portfolio.

So we -- on the margin, we have been, we've been buying almost exclusively floating rate securities over the past year.

And that part of the portfolio then therefore has performed very nicely because it reprices as fast or probably faster than some of the processing deposits, which are supporting it.

Where we've had the compression is really in the adjustable rate portion of the portfolio, where we haven't seen the recess but the cost of the deposit supporting that has gone up.

And as I mentioned, we've haven't -- we've really stopped buying any adjustable rate securities.

They are -- will begin to reprice and either run off or we'll invest in floating.

And therefore, I think, we should see this compression that we've had on the investment portfolio begin to ease and improve over time.

Now, that's obviously a function of what the Fed does here.

But certainly, our strategy has been to really change the sensitivity there.

And we have done that.

And the overall repricing duration is reasonably short, about 2.2 years, which is about as short as it's ever been.

Okay.

And then on the funding side, the one thing that stood out is repo rate that you paid this quarter versus last.

Wondering if you sort of quantify what that cost you this quarter and what we should expect there?

We really don't take much money there, Rob.

So that rate, I think, is probably a little bit distorted.

And it can just be the result of some -- and you're right, it does look a little odd quarter to quarter.

I think you just had some unusually low rates in the prior quarter and perhaps, again, other rates this quarter.

But there's not a whole lot of money.

And it's just, it's not solely a repo rate that you're looking at on that line.

There are some other funds there like TT&L deposits and things like that, which can distort.

If you have them, the rate's low, if you don't have them, the rate's higher.

So, I would just say that there's not a whole lot of funding there that's impacted by it.

And I don't think that's a big factor.

Okay.

And if I could shift gears for a second.

You've talked in the past about trying to get the performance fees to be a little more evenly distributed through the the year.

Is that still the case?

And what should be our expectation for seasonality going forward?

Well, this is Ron O'Hanley again.

The third and the second quarter tend to be our lowest, in that order, tend to be our lowest performance fee quarters.

As you recall, even as recently as two or three years ago, it was very skewed towards, almost completely skewed towards the fourth quarter.

But what you'll see -- what we would expect to see would be the third quarter, net of new business, being slightly less than the second quarter.

And the fourth quarter being significantly greater than both of those quarters.

The next question is from Ken Usdin from Bank of America Securities.

Please go ahead.

I was wondering if you could elaborate just a little bit on the asset servicing growth?

And as far as the strong sequential quarter results both in just the reported and in the JV's, can you talk about it how much of it is coming from new business wins as opposed to incremental cross sales of results?

And what the impact was, if anything, of market impact?

Sure.

It's Jim.

First off, we had conversions of 45 billion in the second quarter of this year.

So, that brings us year to date about 111 billion.

As we mentioned earlier, 2/3 of the business activity is from outside north America.

We would expect to see that continue.

We've got some 292 billion year to date of new wins.

So, we've got some conversions coming up in the third quarter from a large win that we announced in the first quarter, DEPFA, out of Dublin.

We would expect that we continue to see more activity and more growth coming from outside North America over the next several quarters, although as they indicated a moment ago the pipeline in the U.S. is still pretty strong.

So, was the growth on the "on income statement" results also then led by international as well?

Because clearly, the joint venture was very strong and that's where most of the international is.

So, I'm just trying to understand, really, what's the core driver of the "on income statement" growth?

Yes.

As you know, under the equity income method that we use with the JV's, just break that down for you.

They had a showing that in the Canadian joint venture, CIBC Mellon, pretax was up 97%.

And ABN was up 103% versus a year ago.

So, that flowed through to our reporting of about 47% in total.

The other thing would I say is we also had some nice retentions over the last few years.

And the reality is the marketplace has become a little bit more competitive price-wise.

So, as we go through the re-ups over the next several quarters, we would expect there to be some margin compression on some of those deals.

Okay, great.

Thanks a lot, Jim.

The next question is from Gerard Cassidy from RBC Capital Markets.

Please go ahead.

Thank you, good morning.

The question I had was on the performance fees, circling back to that.

Are you finding that your customers are looking for more products that include these performance fees?

Or are you guys marketing more of these products with these fees attached to them?

Well, it's a little bit of both but probably more of the former than the latter.

It's just the nature of what clients are looking for, is they're looking for whether it's liability oriented products, alternatives, et cetera.

Those are typically priced with the performance fees.

But it's not untypical for us, for example, in a fee negotiation, where we are unwilling on a base fee business to go to a level that a client might want.

We will turn around and say, "we won't do that but we'll do a performance fee."

And so I'd put it maybe 60/40 or 70/30, client driven versus us driven.

Okay.

And then, I apologize if you've talked about this already.

But in the -- and I know net interest revenue is small relative to the total revenue number.

In your outlook that you pointed out on page five of the handout, what type of net interest margin are you guys anticipating in the second half of the year?

Well, I think as I said earlier, I don't -- it's a tough number because it really is driven by the level of noninterest-bearing demand deposits that we get in our processing businesses.

If you go back and look in our trend, you'll see that we had been experiencing quarter to quarter 400 or 500 million kinds of increases there.

And then all of a sudden, we didn't have any increase this past quarter.

The portfolio and earning assets kept growing, you have to this impact on the net interest margin, plus the impact of the sales growth.

So, it's a tough one to try to put a number on.

And I don't think we tried to target it.

For example, one of the factors that pulled that margin down a little bit here was we've increased our investment in seed capital for our investment management businesses, which is the way to try to grow that business.

We also had to finance our investment in the WestLB Mellon joint venture.

While that produces interest expense, the revenue comes back in the form of fee revenue.

So, we don't get too terribly focused on what that margin is.

But the positives that we should have for the second half of the year are some of the adjustable rate securities repricing.

And then also I think we have some initiatives to try to grow loans, particularly in our private wealth management area.

And I'm sorry, did you give a reason why the noninterest-bearing deposits really didn't grow like they have in recent past?

It's really a question of sort of special business that you get.

A lot of that is in the Mellon investor services, the shareholder services business where you have a big corporate action or something and the customer is using those deposits to sort, of in lieu of fees, to pay for the service we're providing.

We get a boost to net interest revenue, we get an offset in fees.

And it's just another one of those examples why we don't get too focused on what that net interest margin is.

Because a lot of times, it's going -- it may go up or down but we have an offset over on the fee side.

Thank you.

We have time for one more question.

Thank you.

The last question is from Tom McCrohan from Janney Montgomery Scott.

Please go ahead.

Hi, good morning.

I just have a quick strategic question.

And not to jump the gun on the November meeting.

But Bob, when you look at the businesses and as asset management becomes increasingly more of a proportion of your earning stream at Mellon; do you think there's any detriment to operating an asset management franchise within the context of the bank structure?

Obviously, custody and payments and private clients all make sense to be operating under a bank structure.

But are you looking at possibly as an option, maybe a spin-off of asset management have some type of relationship between a spin-off and the remaining S&P with the bank structure, just so you don't have all the regulatory burdens associated with the bank charter?

Your peers that are pure play asset managers don't have to operate under a bank structure and have -- don't -- as a benefit, don't have some regulatory burdens.

So, is that part of your thinking, a strategy or is it more isolated to expenses?

I think everything that could make our business simpler and easier to operate is on the table from my perspective, Tom.

It doesn't -- if we're incurring an expense that doesn't help our customers or doesn't help our shareholders, it's legitimate to look at it.

And there's no so-called sacred cows out there.

There are advantages and disadvantages to the regulatory environment.

There's clearly a cost to regulatory environment.

But there's some advantages in terms of one other set of eyes potentially looking at us and the benefit that that may bring externally, particularly internationally.

But when we look at the -- I want to continue to be in the banking business.

We have to be because it's really important for our private client business.

And the question is, what is the most efficient way to do that?

We have multiple bank charters, can you get down to fewer or just down to one?

I think that's a possibility.

That would make our regulatory regime easier.

And certainly, our business regime easier.

I considered the cash management business to be important to us just from the standpoint that; a) it's a great product from a customer standpoint and we've had tremendous success with white label type capabilities externally.

Plus, it's also important to our three core businesses, the asset management side as well as the asset servicing side.

So we are looking at -- it's an insightful question you asked and it's something that's amongst the various things we're studying.

We're looking at that as well, is;

How do we make sure that we get complete value from the regulatory regime that we are under?

And how do we make sure that we continue to have great ratings from our regulators but also minimize the cost of doing so?

Assuming it stays under the bank structure and assuming, well just looking at your trend report, earnings from asset management is 45%.

Not including the private clients but from total earnings.

Do you have an objective?

Do you want asset management activities for that segment to represent a certain proportion of your earnings?

No, I wouldn't say that.

The inevitable outcome here is that over time, it appears that asset management and asset servicing is going to grow a lot faster than the payments business.

Although, the payments businesses are good core strong business that eat a lot of our fixed costs.

Over time, one would have to expect that they will be a larger percentage of our earnings, which just seems logical.

Particularly, if we end up doing some more acquisitions in that space.

We certainly saw over the past couple of years that the PE of asset managers tended to be higher than asset servicers.

But if you look from 2004 and before, they were basically on top of each other and we've certainly seen the PE's of asset managers come down over the past several months.

So, I see both of those businesses as being incredibly high growth over time.

Both of them are global, both of them have great synergies between them.

I pointed out earlier in my remarks that our asset servicing business actually helped with 39 mandates in asset management last quarter.

So, we'll talk about more about this in November.

But as a general theme, I suspect that over time, asset management will grow faster than asset servicing.

But both asset management and asset servicing are very high-growth businesses.

I would expect that the private client business, once you get back into a normalized environment, where we're not as investigated quite as heavily as we are now, and the revenues start to come in from those investments; you would think that that would be a 10% plus kind of earner as well.

The cash management business will probably mid-single digits.

And you can do your projections based upon that.

And it will give you a good indication of how our mix will change over time.

I'm delighted, absolutely delighted, with the executives we have running these businesses and for the growth prospects.

Particularly, on the international side, whereas I mentioned earlier, that 2/3 of our new business wins came from outside of North America.

That's a strong indication of just, a) we are doing a good job in North America already.

But we are growing very rapidly internationally.

And that's going to continue, I think, on a secular business cycle basis for years and years to come.

So, stay tuned.

And I continue to be very excited about the prospects for the future.

Clearly, our pipelines are there, our revenue growth is very good and we have an opportunity on the expense side.

And we'll have to deliver that for you.

But thanks for asking.

And thanks, everyone, on the call.

Look forward to meeting with you more in one on one meetings over the next quarter or two.

And hopefully I'll see a number of you in November.

Thank you.

If there are any additional questions or comments, you may comment Mr. Steve lackey at 412-234-5601 or Mr. Andrew Clark at 412-234-4633.

Thank you, ladies and gentlemen.

This concludes today's teleconference.

Thank you for participating.

You may all disconnect.