紐約梅隆銀行 (BK) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

Welcome to the fourth quarter 2008 earnings conference call hosted by the Bank of New York Mellon Corporation.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

Please note that this conference is being recorded.

I will now turn the call over to Mr.

Steve Lackey.

Mr.

Lackey, you may begin.

Thank you, Melissa.

Good afternoon, everyone and thanks for joining us on relatively short notice to review the fourth quarter financial results for the Bank of New York Mellon Corporation.

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 2007 10K, 10Q and other documents filed with the SEC that are available on our website, at BNYMellon.com.

Forward-looking statements in this call speak only as of today, January 20th, 2009.

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

This afternoon's press release focuses on the results of the Bank of New York Mellon.

We have also included a supplemental document the quarterly earnings review available on our home page which provides a five quarter view of the total Company and our six business sectors.

We will use this document as discussion as Todd reviews the results with you shortly.

This afternoon's call will include comments from Bob Kelly and Todd Gibbons.

In addition, there are several members of our executive management team to address your questions about the performance of our businesses during the quarter.

Now I'd like to turn the call over to Bob Kelly, CEO, Bank of New York Mellon.

Thanks, Steve.

Good afternoon, everyone.

Thank you for joining us on such short notice.

Frankly it is pretty good the see 2008 in the rear-view mirror now.

We generated a profit every quarter including in the fourth quarter.

We had record levels of revenue in institutional servicing businesses in Q4, we had outstanding results in foreign exchange and net interest income.

We enjoyed a flight to quality in deposits, widespread in net interest income.

We enjoy volatility in the foreign exchange practice which really helped those revenues.

We continue to have strong deposit levels from our securities servicing clients.

In fact, we gained market share in virtually every business this year.

In asset management we are continuing to gain share in Europe and in money market funds and wealth management we had record net inflows, we had almost $2 billion in new client assets, asset servicing, we had great new wins, including an outsourcing mandate for asset manager and broker dealer services, we continue to gain share.

We have well over 50% share of the US Government clearing market.

In corporate trust and asset servicing we of course won the TARP administration and also the mandate to act as the infrastructure agent for most of the programs in the United States and on a related note we have won similar mandates abroad.

We also continue to win new business in clearing and in treasury services.

When you get past the revenue line we are successful in controlling expenses, you will note that they're actually down 7% year-over-year and down 2% sequentially, and Todd will take you through that.

And you will note we had significant positive operating leverage in the fourth quarter.

The issues with the economy were reflected in our bottom line as we posted only a modest profit after taxes, essentially three reasons.

We recorded a securities write down due to weak markets and an extraordinarily liquid discounts -- illiquidity discounts, in the mortgage backed securities market.

On a loan equivalent basis, our expected loss is much smaller and Todd will speak to that as well.

Over time that we would hope to earn back a substantial portion of these losses.

Secondly, we took a restructuring related to our work force reduction that we talked about a month ago and we also took some expenses relating to our existing capital support agreements.

In our view that's almost all behind us now.

Overall, full year revenue growth was 9% versus 2007, which is something we're pretty proud of.

We outperformed on the merger and integration goals.

We had top-rank client service globally and I don't know if you saw it, but we were just named last week the number one global custodian and number one custodian in Asia in the most recent client survey.

If you think about it, think about life now from a client retention standpoint or client retention in the 18 months that our companies have emerged in the custody business has been over 98%, and I think we are going to officially declare victory now from a client perspective.

Clearly we have demonstrated we did not lose clients as a result of the merger and Jim and Tim and all of the people in the custody and other businesses have done a terrific job of insuring that we not only delivered great client service we actually continued to improve it throughout the merger.

So our business model is working.

We remain incredibly liquid.

Our capital ratios are better than most, and Todd will go through a new schedule for you which is in your deck where we stress test tier one capital and TCE by showing you various levels of what-if analyses on OTTI and OCI, which I hope you find useful.

And finally, we are feeling strategically well-positioned and I think we are going to weather this challenging year ahead as we did in 2008.

So at this point before we get into questions I would like Todd to take you through more detail of what the quarter actually looked like.

Todd?

Thanks, Bob.

Before I take you through the highlights of the quarter, note that for comparative purposes, I will exclude the impact of securities losses from fee revenue, but our operating EPS does include the impact of those losses.

And I will exclude the support agreements and restructuring charges from noninterest expense.

If you look at our results our bottom line does not reflect the strength of the underlying performance.

In a recessionary environment we had a record operating performance from virtually all of our institutional services businesses.

The drivers of operating performance were strong client deposit flows, we saw an increased market share, continued market volatility and very well-controlled operating expenses.

Client deposits, particularly those of if noninterest bearing type, were very strong throughout the quarter.

Custody, Broker-Dealer Services, Corporate Trust and Treasury Services all generated record client deposits, which resulted in a record quarterly level of net interest revenue.

Volatility was also a key driver for us.

We gauge volatility based on a basket of the 30 major currencies and during the quarter exchange rates were volatile, and combined with increased market share we enjoyed a record quarter for our foreign exchange business.

We really held the line on expenses also which helped us again achieve high levels of positive operating leverage and all of our regulatory capital ratio strengthened considerably.

We closed the quarter with a tier one capital ratio of 13.1%, our tangible common equity ratio was stable at 3.8%, a reflection of our strong capital generation from our diversified business mix and a smaller balance sheet.

Now let's get into the numbers.

My comments will follow the Quarterly Earnings Review report beginning on page three.

Our continuing EPS was $0.05.

If you round the numbers it was reduced by a total of $0.88 including $0.65 per share or $752 million from securities write downs, reflecting significant market illiquidity and these securities have an expected incurred loss for us of only $0.10 or $208 million.

There were $0.22 per share from the following: a restructuring expense relating to the 4% work force reduction which we previously announced and which -- that comes to $0.09, and $0.08 associated with the existing support agreements and there was $0.05 of M&I costs.

In an environment that challenged most of our core businesses, our total Company revenue increased by 3% year-over-year and 6% sequentially.

For the full year revenue on an operating basis increased 9%.

Factoring out the expense items I mentioned, we reduced expenses by 7% year-over-year and 2% sequentially.

This strong expense control resulted in 1,000 basis points of positive operating leverage year-over-year and 800 basis points sequentially.

Turning to page five of the earnings review you can see that both assets under custody and assets under management held up relatively well, given the impact of sharply lower market values and the stronger US dollar.

Both continued to benefit from new business.

Turning to page six of the Earnings Review, which details fee growth.

Securities servicing fees were down 7% year-over-year, but if you adjust for the sale of the B&G trade businesses in the first quarter, fees were down 3%, sequentially they were down 5%.

Let's look at the components of securities servicing.

Asset Servicing fees were down 4% year-over-year and 3% sequentially, due primarily to lower market levels and the strength of the US dollar which off-set the impact of net new business, higher securities lending revenue and the impact of the December 2007 acquisition of the remaining 50% of the joint venture with ABN AMRO.

Over the past 12 months we have generated $1.9 trillion of new business, including $690 billion in the fourth quarter.

In December the Global Custodian Survey named BK as the top global custodian for the second year in a row, quite an achievement and valued recognition of the success of our merger.

Securities lending fees were up $20 million year-over-year and $32 million sequentially.

Both increases reflect favorable spreads in the short-term credit markets, offset by decreases in volumes which was driven by lower market valuations and the overall de-leveraging in the financial markets.

Issuer Services fees were down 11% year over year, resulting from lower Depositary Receipt fees due to the timing of corporate action related fees and lower Corporate Trust fee revenue, as a result of lower levels of fixed income issuances globally.

During the fourth quarter we were awarded the mandate from the US treasury to serve as the administrator/custodian/back office for the TARP program.

This win is a reflection of our unique strengths and the capabilities as the largest custodian and trustee in the world.

We continue to see similar new opportunities both domestically and internationally.

Clearing fees decreased 8% over the prior year.

Here, if you were to adjust for the sale of the B trade and G trade execution businesses, fees increased 11%, principally due to growth in trading activity, continued growth in mutual funds and our success in gaining market share from the disruptions in the market.

Asset and Wealth Management fees were off 26% but that's compared to a 38% decline in US equity market and a 45% decline in the global market as we continue to benefit from additional net money market inflows.

Wealth Management continued to see record new sales in the fourth quarter benefiting from strong investor performance at a time when several of our competitors are losing market share.

We are pleased with performance fees of $44 million.

This was driven by two international boutiques.

It is down from $62 million in the year ago period but up from $3 million in the third quarter.

The decline from the year ago period was primarily due to a lower level of fee generated from certain equity and alternative strategy.

FX and other trading revenue jumped 67% over the year and 32% sequentially, where we capitalized on strong client flows and market volatility.

Investment income was you have $24 million, $25 million compared to the fourth quarter of '07, but increased $10 million sequentially.

Turning to NIR, which is detailed on page seven of the Earnings Review, net interest revenue increased 42% year-over-year, and 31% sequentially.

Both increases reflect the higher level of interest earning assets and wider spreads.

Average client deposits increased significantly led by noninterest bearing deposits increasing 84% year-over-year and 56% quarter-over-quarter, as I noted earlier with our institutional servicing clients, continuing to place significant deposits with us.

Our net interest margin was 2.34%, that was an increase of 18 basis points year-over-year and seven basis points sequentially if you exclude FIFO/LIFO charges in the third quarter.

The gain was largely attributable to the increase in free deposits.

Turning to page eight, you can see we managed to reduce operating expenses, excluding the items mentioned earlier, noninterest expenses were down 7% year-over-year and 2% sequentially.

The 7% year-over-year decrease was driven by a 15% decline in total staff expenses which reflects the ongoing benefit of merger-related expense synergies and lower incentives.

Partially offsetting these declines were the impact of the fourth quarter of '07 acquisition of the remaining 50% of the custody JV with ABN AMRO, higher professional legal and purchase service fees, and a $7 million additional FDIC expense related to our participation in the FDIC temporary liquidity guarantee program.

Our participation is expected to result in $50 million of additional expense in 2009.

As I noted up front we took a $181 million restructuring charge related to our global work force reduction program.

The goals of this program are to reduce expense growth beyond the benefits of our merger synergies and further improve the efficiencies of our organization.

We expect to reduce our workforce by 4% or 1,800 positions in 2009, which will create an annualized savings of $160 million to $170 million.

We also expect to record an additional pretax charge of $20 million to $25 million for restructuring in the first half of 2009.

Page nine of the Earnings Review shows the investment securities in our portfolio.

We have again given you details of the asset categories, ratings and fair values for each of these investment categories, as well as the other than temporary impairment write downs that we incurred during the quarter.

At the time of purchase virtually all of the securities were rated AAA.

Over the past year we have seen a continued migration in the ratings and market value of fixed income securities, particularly the mortgage backed ones.

As of December 31st, the ratings continue to be strong with 87% rated either AAA or AA.

And I should note we continue to have the ability and the intent to hold these securities until their prices recover or until maturity.

I would remind you that changes to OCI or other comprehensive income impact our tangible common equity ratio only, while other than temporary impairment impacts our tier one ratio.

We have included for you a new watch list designation to approximately 35% of the portfolio.

These securities are under more credit stress and are generating the majority of the negative marks and impairments.

The unrealized tax net of loss of our total securities for sale portfolio was $4.1 billion at December 31st.

That's an increase of approximately $1.3 billion compared to the prior quarter.

This primarily reflects the underlying performance and wider credit spreads.

Obviously, the housing market indicators and the broader economy have deteriorated since the end of the third quarter.

In addition, securities prices have declined significantly after it appears the TARP program would not be used to purchase securities.

So in the fourth quarter we adjusted our modeling assumptions on all residential mortgage-backed securities with the primary changes being on the default and severity rates.

We increased projected default rates, we increased the projected severity of loss in the event of a default.

And as a result of these adjustments, we reported an impairment charge and wrote down the current market value, certain securities, resulting in a $1.2 billion pretax securities loss.

At December 31st, if we look at the expected loss for example from the Alt-A securities, it is estimated to be $124 million.

This is our estimate of the potential loss of principal if we held those securities to maturity.

However, the impairment charge reflects the additional market discount in today's environment.

And as you might expect the market is using a very high discount rate.

On page 10, you will note we voluntarily called the first loss notes of Old Slip Funding, making us the primary beneficiary and therefore triggering the consolidation of Old Slip which had approximately $125 million in assets.

The consolidation resulted in the recognition of an ordinary loss -- of an extraordinary loss of $26 million after tax or $0.02 per share, representing the current mark to market discount from associated with spread widening for the assets held in Old Slip.

We are pleased to say we have no more conduits.

On October 28th we issued $3 billion of securities to the department of the treasury as part of the TARP.

It was comprised of $2.8 billion in series B preferred stock as well as common stock warrants with an estimated fair value of $220 million.

Since receiving the investment from the treasury we have put the $3 billion to work in several ways.

We used most of the capital to purchase mortgage backed securities and debentures issued by US Government-sponsored agencies to support efforts to increase the amount of funds available to borrowers in the residential housing market.

We also purchased securities of other financial institutions which helps increase the amount of funds available to lend to customers -- excuse me to consumers and businesses.

We also continued to make loans to other financial institutions through the interbank lending market.

All of these efforts directly address the need to improve the liquidity in the financial system and are consistent with our business model as the bank that primarily serves institutional clients.

I will emphasize that we will not use the funds to pay dividends, bonuses or incentive compensation of any kind.

Prior to this investment we were already well-capitalized.

With this investment and the lower level of risk-adjusted assets our tier one capital ratio is now 13.1%.

At period end our tangible common equity ratio was 3.8%.

I will note here that certain rating agencies include a portion of the series B preferred stock and trust preferred securities when assessing our capital strength.

Using the lowest allocation permitted by the four agencies, our TCE was [4.50] at the period end.

On page 12 we have included a new disclosure which gives you a window into the stress testing we routinely perform on the adequacy of our capital base.

We have modeled the impact toward our tier one capital and tangible capital ratios for increasing levels of impairments and unrealized losses related to our investment securities portfolio.

Please note that impairment charges impact tier one only, and unrealized losses impact other comprehensive income, which only impacts tangible common equity.

As you can see if we took another $5 billion of impairment charges, we would have a strong pro forma tier one ratio at the end of 2009.

So we continue to be comfortable with our capital levels.

Now turning to our loan portfolio, during the quarter we raised the provision for credit losses to $60 million.

Charge offs were less than the provision at $25 million and nonperforming assets increased by $25 million to $292 million.

I should add that we've had great success in reducing our total loan exposure over the last couple of years.

At the time of our merger we had set a goal of reducing our total exposure by $4 billion.

By year-end we had reduced it by $10 billion and we have now set a target of further reducing it by an additional $4 billion.

Our results include an income tax benefit of $135 million.

If we were to exclude the impact of the securities write downs, the restructuring charge, the support agreement charge, and M&I, effective tax rate was 32.6%.

Turning to the integration front which we have got outlined for you on page 14, we remain in excellent shape on all of our key milestones.

We achieved $258 million in revenue synergies against our full-year target of $180 million.

We reached $157 million in expense synergies during the quarter which is $13 million higher than the third quarter.

For the full year we realized $550 million in expense synergies, well ahead of our target.

And we continued to exceed our client retention goals in asset servicing.

Quality remains very strong and in the Global Custodian just released we ranked number one among all global custodians.

In summary, we have a fairly conservative view of things for 2009, a view that we have been articulating consistently over the past few months.

Realizing that there will be challenges to the top line, we are more committed than ever to controlling expenses and driving through the synergies from the merger.

We are fortunate we have -- we are positioned to continue to benefit from disruptions in market share gains across all of our businesses.

And with that, let me turn it back to Bob.

Thanks, Todd.

I hope you found that to be a useful review.

Why don't we go right to questions at this point if we could.

Operator?

Thank you.

We will now conduct the question and answer session.

(Operator Instructions).

One moment please for the first question.

Our first question comes from Mike Mayo from Deutsche Bank.

Please go ahead.

Good afternoon.

Hi, Mike.

Three questions.

First, on capital, your 3.8% tangible common equity and that is not -- it could have been worse, but it is still below your 5% target.

Does your 5% target still hold and how do you think about that ratio?

Yes.

Let me start that.

I would say we de-emphasized the 5% last quarter, Mike, given the global government emphasis on tier one, and the 3.8%.

You also have to think about it in terms of how rating agencies think about it.

And as detailed in the numbers, the S&P and Moody's, kind of think about it as including some of the TARP money as well.

So rating agencies would think of it as something north of 4%.

And second question, your noninterest bearing deposits is up 1/2.

Where does that come from, why does it go to you and how sticky are those deposits?

Well, I will take that and I think some of the executives running our businesses can add.

It is really coming from all of our businesses.

Mike, we saw a fair amount when you saw interest rate cuts and the yield in treasury fund decline pretty dramatically.

We saw a fair amount of clients just parking those funds with us.

And so I think this is part of the flight to quality where you see funds come into either money market funds, treasury funds or sitting on our balance sheet.

But it is really across the board.

It is no one single business.

We are seeing it in corporate trust, we're seeing it in custody, we're seeing it in our broker dealer services business, we're seeing it in our treasury services business.

All client money.

It is all client money.

I don't know if anybody has anything to add to that.

No, you covered it well.

Todd.

In terms of stickiness, Mike, we continue.

This is Gerald.

We continue to operate at pretty high levels of interest free deposits even though the market is up until today it calm down a little bit.

Why does it (inaudible) Where is it coming from?

Which type of firm?

Maybe I can pipe in.

Mike, it is Karen Peetz.

Just specific to corporate trust which is a big driver, a lot relates to it is bond holder money waiting to be paid off.

So safe haven and safe harbor is particularly important.

That's a big driver in the issuer services sector.

We don't expect it to stay here forever.

That's for sure, Mike.

That's why we've got it in such an incredibly liquid and a lot of it just sitting in the account at the fed.

Some of it may come for example with redemptions, we may see a decline in the first few quarters here.

And third question, as it relates to new mergers what is your appetite, clearly competitors are more in the back than you are at the moment.

Would you try to act opportunistically?

Mike, it is Bob again.

We are, as I said earlier in my opening remarks we are gaining share through organic growth in just about every business we have.

We will continue to do that.

The number one priority for us is to deliver fantastic client service.

And we have been saying for numerous quarters here that we haven't really been interested in acquisition opportunities, and frankly I just never speak directly about merger or acquisition opportunities.

We will see how the year plays out.

It is clearly a difficult environment, and we feel we are well positioned here.

All right.

Thank you.

Thanks, Mike.

Thank you.

(Operator Instructions).

One moment.

Thank you.

Your next question comes from Nancy Bush with NAB Research.

Please go ahead.

Hi, guys, how are you?

Hey, Nancy.

Good.

I have a question on your accounting for the -- or the uses of the TARP.

My understanding is that is to be formalized.

Has there been goals or targets set down for you guys?

And I guess my question is how far can you stretch $3 billion in TARP funds?

Well, Nancy, what we did was, first of all we don't have any leverage, we are not out buying wholesale funds, so the TARP isn't something we would lever.

So when we receive the funds, as we would with any situation, we sat down with our [alco], and we said what would, how shall we invest this.

We do have a $3 billion larger balance sheet.

How should we invest this in the spirit of the purpose for what we received it, and also within our business model which is obviously a -- we are not a consumer lender and we didn't expect the regulators would expect us to change our stripes.

So we came up with a program to help the interbank market.

It was at a time when the inner bank market was really struggling.

We put a fair amount into the interbank market and we put it out for little longer terms with institutions we felt comfortable with and we also invested in the government sponsored entity, agency mortgage backed securities as well as their straight debentures.

That served the purpose.

We've also had ongoing discussions with our regulators as well as the treasury, and we have reflected exactly what it is that we have been doing with those funds to them and they seem supportive.

Okay.

And secondly, if I may ask and forgive me if you have discussed this it's been kind of a long day.

Could you speak to NIM, net interest margin trends?

Yes.

We had the net interest margin is primarily driven by the very high level of free deposits.

We do expect to continue to see a pretty high level of free deposits.

We would expect them to normalize a little bit.

There are a couple of things that benefit us -- that have benefited us here.

Number one, the very wide interbank spread is a real positive.

We can enjoy quite a bit of spread on those deposits.

We would expect that to compress.

It has compressed somewhat significantly, we would expect that to continue to compress.

Also the overall level of interest rates have come down, so those free deposits are going to have less value to us.

So kind of the windfall from this should be compressed, because obviously we don't, we can't think long term.

We don't think these are going to be here forever.

So the windfall that we enjoyed in the late third quarter and fourth quarter we wouldn't expect to move forward.

We do however expect that LIBOR spreads will continue to be wider not wider than they were 2008 but certainly '06 and '07.

So that's a positive.

And frankly, Nancy.

It is Bob, we would like to see these spreads come back to more normal levels, because that implies the financial system is getting back on its feet again.

You and everybody else, Bob.

Thanks.

Thank you.

Thank you.

Our next question comes from Glenn Schorr with UBS, please go ahead.

Hi.

Thanks.

Two quickies.

One is in the access that moved over to help maturity last quarter, could you just give us a bit of a break down of what got moved in?

And if you were, if they were not moved in I am curious what the unrelated loss component would have been on that piece of the portfolio.

Sure, Glenn.

We moved about $7 billion in securities, about half of them were floating rate notes and about, and I'm giving you some rough statistics here, I don't have it off the top of my head.

About half were residential mortgage backed securities.

We moved them on September 12th and it was right around the time of the Lehman collapse.

Frankly we thought there was a pretty high probability that asset prices would further decline as a result of that.

Had we not moved them, the impact to our other comprehensive income we estimate would have been a little over $500 million.

Pretax?

That's after tax.

After tax.

The after tax effect.

Good timing on your part, not sure -- it is just a matter of moved or not but the time.

And then the other question on sec lending portfolios, especially on the commingled side.

Just curious on your thoughts of if all of the industry commingled funds just have that same kind of under a $1 NAV just because spreads have widened and assets have gone down, if you're experiencing similar types of customer issues that we have seen around the industry?

Glenn, are you on a cell phone?

I am not.

I will transfer over to my -- I am on a headset and I will pick up the handset.

Yes.

You are.

We are losing you.

Is that any better?

Better?

Yes, that's better.

Okay.

So the question was the sec lending portfolio, and if your sec lending portfolios have any of these below the buck on the commingled side and if you are having customer issues similar to what we have seen in the industry?

Jim, you want to --

Yes.

It is Jim.

We have about 12 different funds that support our securities lending activity.

We have a completed average on those funds of about just under $0.975 and they range from about $0.92 up to $1.

We are able to operate all of those funds by very carefully managing the liquidity levels.

We have been operating them on a dollar in, dollar out basis.

We have been able to honor all of the trading activity that occurs on an daily basis.

And then for unusual activity that may occur from a given client, if they were to look to exit, they go out in the form of a vertical slice.

Meaning some cash and some assets in kind.

That's right.

They go out in kind.

Okay.

Thanks very much.

You're welcome.

Thank you.

Our next question comes from Tom McCrohan with Janney Montgomery Scott.

Please go ahead.

Hi, everyone.

There is a pretty significant echo I am hearing on my end just so you guys know.

For Jim, what was, can you just remind us what were the total dollar amount of the commingled funds that are unregistered within your various programs?

Tom we are also losing you there.

We are going to check with the operator to see if we can clarify this line.

Hold on a second, Tom.

Are you on a headset?

Not anymore.

Okay.

You are sounding better.

Try that one more time?

Sure.

If you can remind us the total dollar amount is of all of the commingled funds within the securities lending programs that are unregistered?

The unregistered piece is about $34 billion.

And what is the NAV on those right now?

They range anywhere from $0.968 up to $1 even.

Okay.

And are the capital support agreements, are any of the existing capital agreements contractually obligated to the bank to support that $34 billion?

The question, are there any of the capital support agreements that are required to support that $34 billion.

Not that I'm aware of, right Jim?

And of all the capital support agreements, what do we have left at this point, Todd?

In this quarter we took a charge under a capital support agreement of a little over $160 million, and that was a reflection of the value of the underlying assets for the most part, and if kind of the worst case scenario that we have estimated is $150 million of additional.

Are you hearing us clearly now?

I can hear you clearly but there's an echo.

I will jump off.

Thanks.

Sorry about that.

It's unintentional.

Thank you.

(Operator Instructions).

One moment.

Okay.

I do have a question from Ken Usdin of Bank of America.

Please go ahead.

Hi.

Thanks, good afternoon.

Just wondering on the TCE ratio, just walk us through again the ins and outs of that.

Just trying to make sure I get an understanding of what the balance sheet size is to that calculation.

Ken, we lost you as well.

But I think your question was what is going on in the TCE ratio.

There's really, you know, obviously two aspects to it.

And the numerator, it declined, this isn't adjusting it, this is the standard calculation.

We did lose about $1.6 billion in tangible common equity largely due to the valuation adjustments in the portfolio.

And the balance sheet came down in size as well as risk-weighted assets, but as well as total size.

So the denominator came down probably over $35 billion to $40 billion.

And the combination of the two held it fairly constant.

What we did exclude in calculating the denominator, we did exclude the very large deposit that we are leaving at the fed.

It is obviously a zero risk and it's just to the unusual nature of those free deposits that are coming with us.

And that's consistent with last quarter as well.

It is consistent with what we did at 9/30.

That's the $50 billion?

Right.

Ken, I should add to that is, we had pretty strong earnings and the earnings basically offset the impairment and the impairment reduced the unrealized loss in the portfolio.

Okay.

Ken and everyone on the call, I would encourage you to look at page 12 again, and just that does really provide you with great what if scenarios that are pretty brutal on the OTTI side.

And given all of the write downs we have taken on the OCI standpoint, we have really stress test that as well.

So in just about any scenario, that you could paint for this year, I think you can pretty easily see that we have capital levels that will meet the test here.

Okay.

I will try to talk through my second question.

With regards to the $1.2 billion of OTTI impairments, there's a portion of it is that is expected loss and then there's a portion of it that is not.

Can you help us understand over what time period would you expect to reaccrete?

Ken, I think I know where you are going with the question but I didn't hear the end of it.

Why don't you repeat it for him, what you think you heard.

If we could explain the difference between the economic loss and the mark to market loss; is that correct.

That's the first part.

The second part is that over what time period would you expect that loss to reaccrete assuming everything did mature at par?

Okay.

The way we calculate it is we, we take what we think our conservative estimates of defaults and severities, we do a roll rate analysis on a security by security basis, and we conclude that yes the security might lose at let's say 10% of the principal.

We have been reasonably conservative relative to the market and how we are doing this.

So if we're losing 10% of the principal, we look at the market value of the secure, and let's say it is $0.50.

We have been able to ascertain that the market is discounting securities at about a 20% rate, 15%, it is actually in the 15% to 25%.

So they're doing a cash flow analysis, they're discounting it at 15% to 25%.

We have typically got a coupon of something like 5%.

So you can do the arithmetic, if you've got a few years of duration, the market price is going to be at a significant discount to the expected loss.

What I would just say, just as Todd continues here, is the way I just think of it is that the difference between what you take to the income statement and the expected loss is only the discount rate.

All the other assumption are the same.

So the expected loss is discounted like a loan.

This makes it -- the expected loss is a loan equivalent basis.

That's the pitch that the major accounting firms were proposing last quarter, why don't you treat securities much like loans, and again, the other difference is the discount rate, something at the expected loss rate might be 5% or 6%, and on the mark to market might be at a 20% to 25% annual yield.

So that might end up with a situation where you think you are going to lose $0.10, the markets at $0.50.

So what happens to the $0.40 differential.

Right now you have got to figure out what you think the duration of these assets are and it is hard to estimate, but we think they have extended significantly.

So what might have been three or four year security might be five or six year security.

So it would be over a relatively long time period that we estimate that we would accrete that back, and the methodology for doing that frankly we have not worked out at this point.

But it could be a couple hundred million a year type thing, back of the envelope?

That would probably be the high end of it.

Okay.

Thanks, Ken.

Thank you.

Our next question will come from Betsy Graseck from Morgan Stanley.

Please go ahead.

Thanks.

Couple of questions.

one is the investment portfolio capital ratios stress test on the TCE and Tier 1, why did you stop the stress test at $3billion on the TCE ratio?

It was -- Betsy, it is Bob.

It was pretty straightforward.

If you go back to the securities schedule, we already took over $7.5 billion worth of mark to market write downs through OCI already, the last year, that most of that occurred of course in 2008.

And the watch list securities are now down to $0.60 on the dollar.

So in just about any reasonable scenario by taking another $3 billion, that's another very material write down in '09 from '08, and that would take you for the watch list well below $0.50 on the dollar.

But having said all of that if you want to take it further you can, obviously.

You can see on a relative basis per $1 billion what it would be.

But from a management perspective we just didn't realistically see it going beyond that, particularly if we expect to see something this year, we are starting of course on the weekend starting to see more and more talk of whether or not the TARP asset repurchase program will be started up again and whether or not a bad bank would be created or other types of vehicles would be created.

Since OTTI is new, we made it a much bigger number, and since OCI was something that has been around for a while, we just went with a slightly smaller number but still a very material one.

And Betsy, the assumptions in these prices are already pretty darn draconian.

Who's not to say you couldn't see more than $3 billion but that's a -- that's basically saying everybody defaults and you have severe losses even on those defaults.

So we think given just how draconian the assumptions were, that's a good place to stop, you can certainly push it more if you like.

Okay.

I'm just wondering (inaudible)

No.

That was not the implication.

It was just reasonable stress levels in a really tough environment being assumed in '09.

Can you give us an update on how you're thinking about the dividend at those stress levels?

Just looking at those stress levels, you would have to conclude that we feel pretty comfortable with the dividend levels, because that assumes the balance sheet size of what we have today, as well as the existing dividend levels.

I guess we could look at it every quarter, but those numbers if you backed out some portion of the dividend, you will see that the impact is not really that material.

It does provide some level of basis for us, but it's not super material.

So we continue that we should comfortable with the dividend.

Thank you then, Betsy.

Thank you.

Our next question comes from Mike Mayo from Deutsche Bank.

Hi.

Thanks for taking my follow up.

So your TCE ratio remained flat even though you didn't earn much money this quarter and you had higher underlying securities losses because you downsized the balance sheet by 12%.

Can you confirm that?

Sorry, Mike.

You really broke up on that one.

The bottom line is your TCE ratio was helped by downsizing the balance sheet by 12%?

That's correct.

There's two aspects to it, Mike.

First of all we did have a significant decline in the value of the portfolio.

Our earnings offset about half of that decline and we took it through earnings.

And of course, we had an incredibly unusual ballooning of the balance sheet in the third quarter.

We had a high spike in the balance sheet.

So, our earnings I want to make sure I get the pretax and after tax impact here.

We took $1.2 billion, pretax charge to our earnings.

That's $752 million after tax.

That ate into what would have otherwise gone against the TCE ratio, because otherwise we would have had a bigger valuation adjustment.

We then had a significant valuation adjustment even after that which was offset primarily just as you pointed out by a smaller balance sheet, but we had a very unusual balance sheet on September 30th.

We still have an unusually large balance sheet today.

And it is not that we managed it.

It was what our clients wanted to do and I would think, Mike, that ultimately if the markets continue to stabilize our balance sheet could get smaller.

Right.

So what is your outlook for 2009, if you continue to downsize the balance sheet (unintelligible) or what's your outlook for 2009?

What I really want to point out, Mike, is that there was a spike in the balance sheet, and I'd call this a little bit of what you saw in the third and fourth quarter, a windfall.

And a lot of the revenue was driven by placements, and we don't expect that to be an ongoing feature.

I would go back to the levels in the first and second quarter of last year.

Okay.

So at this point -- thanks, Mike.

At this point we are going to wrap it up.

We don't have anymore questions.

I really appreciate everyone getting on the call and asking the good questions as always.

We are going to work hard for you, and we look forward to filling you in with more details when you talk to the IR folks, and wish you all the best.

I know this is an extraordinarily difficult and tiring time right now, and thank you for dialing in.

All the best.

Thank you.

If there are any additional questions or comments, you may contact Mr.

Steve Lackey at 212-635-1578.

Thank you, ladies and gentlemen.

This concludes today's call.

Thank you for participating.