紐約梅隆銀行 (BK) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the second-quarter 2014 earnings conference call hosted by BNY Mellon.

(Operator Instructions).

Please note that this conference call and webcast will be recorded and will consist of copyrighted material.

You may not record or rebroadcast these materials without BNY Mellon's consent.

I will now turn the call over to Mr. Izzy Dawood.

Mr. Dawood, you may begin.

Thanks, Wendy, and welcome everyone.

With us today are Gerald Hassell, our Chairman and CEO, Todd Gibbons, our CFO, as well as our executive management team.

Before we begin let me remind you that our remarks today may include forward-looking statements.

Actual results may differ materially from those indicated or implied by the forward-looking statements as a result of various factors.

These factors include those identified in the cautionary statement in the press release and those identified in our documents filed with the SEC that are available on our website, BNYMellon.com.

Forward-looking statements in this call speak only as of today July 18, 2014, and we will not update forward-looking statements.

Our press release and earnings review are available on our website and we will be using the earnings review to discuss our results.

Now I would like to turn the call over to Gerald.

Great.

Thanks, Izzy, and welcome, everyone and thanks for joining us this morning.

So a few key takeaways for the quarter.

We are attacking our expense base as we continue to align our operating model with the reality of the macro environment.

We are absolutely committed to aggressive expense management and to reducing structural costs and it is paying off, helping us generate positive operating leverage during the quarter.

Investment Management fees and most of our Investment Services fees continue to grow demonstrating our ability to meet the increasingly complex investing needs of our clients.

Our capital position remains strong as does our ability to generate capital providing us with the financial flexibility to continue to return capital to shareholders.

So looking at our performance during the quarter.

As you saw from the release, we reported earnings of $0.48 per share which included a $0.14 per share charge covering two items we previously disclosed.

One, was a charge related to certain Investment Management funds, and two, a severance charge related to progress in streamlining our organization which I might add is expected to benefit our expense runrate in excess of the $120 million charge.

And we should begin to see the benefits this year with a full effect in 2015.

Now when you add these items back, one might say that we earned $0.62 per share but we think we really earned about $0.58 per share on an operating basis.

So turning to revenues.

Total revenues were $3.7 billion.

Investment Management had a good quarter and continues to demonstrate why we value this business.

Investment Management and performance fees were up 4% year-over-year and they were also up 5% sequentially.

Assets under management increased 15% year-over-year to a record $1.64 trillion and we are continuing to execute on our initiatives to drive future earnings growth including our strategy to increase our focus on individuals as investors, by broadening our reach to intermediaries and the retirement market, and by expanding wealth management.

Now another key strategy involves building out our local capabilities for clients looking to invest in Asia.

In fact, in APAC, we are currently on-boarding our first client onto the separately managed account platform that we built in conjunction with our Pershing operation.

So were not only attracting clients that will use our technology but we are also getting asset management mandates on it as well.

During the quarter, Insight Investment was named the winner of Global Investor Magazine's annual award for investment excellence as asset manager of the year in its category.

Insight was also named the LDI manager of the year by the UK Pension awards.

So great performance in our investment sector in that regard.

All in all a good quarter for Investment Management which remains a significant earnings contributor and capital generator for our firm.

We like the fact that this business is balance sheet light and that it continues to serve as a valuable role in allowing us to leverage and deepen our client relationships across the Company.

In Investment Services, asset servicing, clearing and treasury services fees grew nicely while issuer services was down.

Investment Services business was again helped by the growing contribution from global collateral services which showed good growth during the quarter as usage of our optimization and segregation solutions continues to increase.

In global markets, the industrywide low volatility negatively impacted our revenues but we have been to offset that partially as enhancements to our FX platform drove a significant increase in volumes.

So again, our investments are paying off.

Now during the quarter, our asset servicing and global collateral services capabilities received a number of awards for innovation, service quality and the strength of our capabilities and we again came out on top of our peer group in a key industry survey.

This time in Global Custodian Mutual Fund Administration Survey.

Now on the expense front earlier this year, we outlined some of the actions we are taking to manage expense growth including streamlining our organization, reducing our real estate footprint, consolidating platforms, reengineering processes and getting more out of each technology dollar we spend.

I said you would see evidence of all these moves this year and our progress is now being reflected in our numbers.

We succeeded in reducing operating expenses both year-over-year and sequentially notwithstanding the impact of regulatory, risk and control-related expenses.

So let me highlight two important areas.

The first item involves reducing employee costs.

We made good progress in streamlining our organization which includes reducing positions and layers and getting to fewer, more effective managers.

The employee cost reductions are real and very sustainable.

But while the cost savings are important, these actions are not just about cost, they are about creating an organization that is better aligned and connected with our clients and markets and cultivating a high-performance culture.

Now in part of these moves, we promoted Brian Shea to head Investment Services, bringing the front and back end together to drive better client solutions and improve our productivity and efficiency.

Curtis Arledge added to his responsibilities the oversight of the newly formed BNY Mellon Markets Group, which brings together global markets, global collateral services and prime services.

Now Curtis has extensive experience in capital markets and asset management and it gives him a unique insight into the markets and needs of our clients both buy side and sell side clients.

That together with the new structure will help to further accelerate the delivery to clients of solutions in trading, securities financing and securities lending.

I might add importantly our clients have told us this is how we should be organized to better serve them.

The second expense item is our real estate footprint.

You saw that we reached an agreement to sell our 1 Wall Street building for $585 million, which will reduce our New York City footprint by 750,000 square feet.

Now in terms of the future financial impact, there will be some incremental expense in 2015 as we work through some overlapping occupancy expense.

And in 2016, we will see the benefit of this action and Todd will cover this more in just a moment.

Now our focus is on driving productivity improvement across our businesses, across geographies, across functions and doing it aggressively every single day.

Turning onto the capital front, we continue to generate significant levels of capital resulting in strong capital ratios which provide us with the financial flexibility to return more to shareholders and drive shareholder value.

During the quarter, we increased our dividend by 13%.

We repurchased 12.6 million shares.

Now another compelling statistic, since the financial crisis, our strong capital generation has enabled us to more than double our tangible capital while also reducing our shares outstanding below pre-crisis levels.

Now before I hand it over to Todd, let me wrap up with an update on our corporate trust business.

Back in May we told you we were exploring whether the corporate trust business is worth significantly more to someone else rather than to us.

We have now completed that process.

When we weighed the benefits of the sale of the current environment against both the near-term pressures on this business and the more positive long-term outlook, we concluded that we can create more shareholder value by retaining it.

We will continue to focus on driving profitable growth.

This business is positioned to benefit from the significant upside for earnings and operating margins that will result from an eventual move to more normalized monetary policy, the expected abatement in structured debt maturities, and a potential recovery of the non-agency mortgage-backed market.

I have always liked this business and our leading market share position and I am confident of its future growth potential.

The bottom line is we are executing to drive shareholder value through a focus on three activities.

One, streamlining our organization and continuously finding ways to improve our productivity and efficiency, primarily through enhancement to our technology and operations and by sustaining the momentum that we have established on the cost front.

Two, executing on our initiatives to drive revenues and profits, focusing on growth opportunities such as individuals as investors, our APAC Investment Management strategy, leveraging our Investment Services scale to develop highly effective mid- and back-office solutions, and enhancing our collateral systems and FX trading platforms to provide clients with better liquidity management tools.

Finally, complying with a host of new capital, liquidity and other regulatory requirements and doing it as efficiently and effectively as possible.

Now as I said before, we expect to see the benefits of all of these actions to continue to show up in our numbers this year.

With that, let me turn it over to Todd.

Thanks, Gerald, and good morning, everyone.

My comments will follow the quarterly earnings review beginning on page 2.

As Gerald noted, EPS was $0.48; the $0.48 includes the $0.14 for the previously disclosed items.

It also includes a benefit of approximately $0.04 between the credit provision which was negative for the period as well as a little bit higher than normal investment and other income.

So all in, we view it as about a $0.58 quarter.

Looking at the numbers on a year-over-year basis, total revenue was $3.7 billion.

Investment Services fees were down 1%.

We saw some strength in asset servicing and clearing services but that was more than offset by the weakness in issuer services and we will talk about that in a minute.

Investment Management and performance fees were up 4% and if you exclude money market fee waivers, they were up 5%.

FX was down on the lower volatility numbers and NIR was down 5%.

Expenses on an adjusted basis were down 4% so for the quarter, our operating revenues were a little soft, down about 2% year-over-year but we more than offset that by the decline in expenses enabling us to generate 200 basis points of positive operating leverage.

We do expect the revenue growth rate to recover in the third quarter.

Turning to page 4 where we call out some business metrics that help explain our underlying performance, you can see that we had record AUM of $1.64 trillion.

That is up 15% from a year ago driven by higher market values as well as new business.

During the quarter we had net long-term outflows of $13 billion and short-term outflows of $18 billion.

The long-term outflows were primarily driven by liability driven investments, AUM, where we had one client that opted to bring that service back in house.

Assets under custody and administration at quarter end were $28.5 trillion; that is up 9% year-over-year.

It primarily reflects the impact of higher market values as well as some currency impact.

Linked quarter AUC/A was up 2% due also to improved market values.

For the quarter, we had an estimated $130 billion in new AUCA wins.

Looking into our key metrics, you can see it showed growth year-over-year on most of them.

Average loans and deposits in wealth management and Investment Services continued their growth trend.

The market value on securities and loan at period end grew and most of our clearing metrics were up while DARTs volumes were actually down.

On the flip side, DR programs and average tri-party balances were down slightly.

In terms of the key external metrics, both equity and fixed income markets were up but I would point out that fixed income appreciation trailed the equity market improvement and as we discussed before, our AUM and AUC/A are more oriented toward fixed income assets.

The FX Volatility Index average was off 37% from the lowest average in the quarter since pre-crisis impacting FX revenue and the average Fed Funds effective rate was down 3 basis points or 25% from last year which had a negative impact on our money market fee waivers.

Looking at fees on page 6, asset servicing fees were up 3% year-over-year, 1% sequentially.

The year-over-year increase reflects higher market values.

It also reflects the impact of a weaker US dollar, net new business and organic growth, partially offset by lower securities lending revenue.

The sequential increase primarily reflects seasonally higher securities lending revenue and higher market values.

Clearing fees were up 2% year-over-year and up slightly sequentially.

The year-over-year increase was driven by higher mutual fund fees partially offset by a decrease in DARTs and higher money market fee waivers.

Issuer services fees were down 21% year-over-year and up 1% sequentially.

The year-over-year decrease reflects lower dividends fees partially due to timing and corporate actions in DRs.

In addition, the comparison was impacted by lower customer reimbursements in corporate trust as well as higher money market fee waivers and that impact of the continuing net maturities in corporate trust.

The good news as Gerald indicated is that we can see the net maturities of structured securities abating in the next 18 or 24 months as the pace of the maturities slows and the impact of the new business should begin to more than offset it.

When you look at Investment Services, you will see that our Investment Services fees as a percentage of noninterest expense declined from 94% to 93%.

However, if you adjust for the money market fee waivers and also the impact of the issuer services business for the quarter, the ratio actually improved by 1% demonstrating some operating leverage there.

Investment Management and performance fees were up 4% year-over-year and 5% sequentially.

Both increases reflect higher equity market values and the average impact of a weaker US dollar.

The year-over-year increase also reflects net new business which was partially offset by money market fee waivers and lower performance fees.

The sequential increase also reflects lower money market fee waivers and higher performance fees.

Excluding money market fee waivers, Investment Management performance fees were up 5% year-over-year and 3% sequentially.

In FX and other trading, revenue was down 37% year-over-year and down 4% sequentially.

Looking at the components, FX revenue of $129 million was down 28% year-over-year and 1% sequentially and that is primarily reflecting lower volatility offset by higher volumes.

In fact if you look at the composite on page 5, you can see that market volatility was down 37% year-over-year and 20% sequentially so clearly we are capturing higher volumes.

Other trading revenue was down $27 million from the year-ago quarter and $5 million from the first quarter.

The decrease from the year-ago period reflects lower derivatives trading and the sequential decrease primarily reflects lower fixed income trading.

In the second quarter, we exited one of the derivatives business lines and Curtis and Kurt are considering further actions to improve the performance of this unit going forward.

Investment in other income was $142 million in the quarter compared with $285 million in the year-ago quarter and $102 million in the prior quarter.

The year-over-year decrease primarily reflects a gain related to an equity investment reported in the second quarter of 2013 and that was offset by higher other income and seed capital gains.

The sequential increase primarily reflects higher other income, equity investment revenue, and asset-related gains which was partially offset by lower lease residual gains in the quarter.

Turning to page 8 of the earnings review, you will see that NIR on an FTE basis was down $35 million versus the year-ago quarter and down $8 million sequentially.

The year-over-year decrease resulted from lower yields on investment securities and that was partially offset by higher average earning assets which is largely driven by higher deposits.

The sequential decrease was primarily driven by the higher premium amortization on agency mortgage-backed securities.

As you will recall from previous quarters when rates do go down, the premium amortization rate actually increases.

The net interest margin for the quarter was 98 basis points, down from 115 a year ago and 105 in the first quarter.

Turning to page 9, noninterest expense included two nonrecurring items.

The first was $109 million charge related to the previously disclosed administration of certain Investment Management funds.

With this charge we are adequately reserved for this issue.

I would point out that the charges have been broken out in the Investment Management disclosure which will enable you to evaluate the segment's results on an actual operating basis.

The severance charge of $120 million related to the streamlining actions which Gerald mentioned in his earlier comments.

This charge was included in the M&I, litigation and restructuring line.

These actions will benefit our expense run rate in the second half of this year and I will give you a little more detail on that in a moment.

Looking at our results adjusted for these items, total noninterest expenses were down 4% year-over-year and 2% sequentially.

Both decreases were primarily driven by a 5% reduction in staff expense and we were able to do that despite the impact of increased regulatory risk and control expenses.

The year-over-year decrease also benefited from a 24% reduction in the business development expenses.

On page 10, you can see that at quarter end we had a net unrealized gain on the investment securities portfolio of $1.2 billion.

This increased from $676 million at the end of the prior quarter.

It was driven by the lower rates that we saw in the quarter.

Looking at our loan book on page 11, you can see that the provision for credit losses was a credit during the quarter of $12 million which was driven by the continued improvement in credit quality of the book.

This compares to a credit of $19 million a year ago and a credit of $18 million in the first quarter.

Turning to capital on page 12, at June 30, 2014, our estimated Basel III common equity Tier 1 ratio fully phased in under the standardized approach was 10.4% compared to 11.1% at the end of March and under the advanced approach, it was 10% compared to 10.7% at the end of March.

The 70 basis point sequential decrease primarily reflects an increase in risk-weighted assets related to the assets of certain consolidated Investment Management funds.

As a reminder, the fully phased in common equity Tier 1 ratio will be effective in 2019.

Also in the second quarter we exited the new parallel run under the Basel advanced approaches and are now required to perform both standard and advanced transitional calculations.

The binding of these ratios is the lower of the advanced or standard common equity Tier 1 which is currently the advanced at 11.7%.

Note that the quarter-over-quarter decline in our transitional risk-based capital ratios has two main components.

First of all, the switch this quarter to using the advanced approach methodology is the most significant one and the impact of the assets of the consolidated Investment Management funds I just mentioned also impacted it.

Our estimated supplemental leverage ratio was flat during the quarter at about 4.7% and that is despite a 4% sequential increase in the average balance sheet.

During the quarter we repurchased 12.6 million common shares for a total of $431 million and the effective tax rate for the quarter was 26.7%.

Before moving to some outlook comments, let me spend a few minutes on the two transactions we expect to close in the third quarter.

First of all, the sale of our equity investment in Wing Hang actually has already closed in the third quarter.

Next, third quarter's results will include an after-tax gain of approximately $320 million.

Note that our equity investment revenue related to Wing Hang totaled $20 million in the first half of 2014 and $95 million in 2013.

The 2013 numbers includes a gain that we had with a sale of property of about $37 million.

Also, the 1 Wall Street building is expected to be -- the closing of it is expected to be done in the third quarter.

It will result in after-tax gain of approximately $200 million, $345 million pretax.

We have entered into a new lease now for a new corporate headquarters which we expect to occupy by the end of 2015.

A few points to factor into your thinking about the current quarter and beyond.

Third-quarter earnings are generally impacted by seasonal downturn in transition volumes and market related revenues particularly foreign exchange and securities lending while DRs tends to be much stronger in the third quarter.

Two transactions will impact investment in other income going forward as I noted earlier.

The Wing Hang investment contributed approximately $10 million per quarter to the line item in the first half of the year.

In addition, we recently adopted accounting standards related to low income housing.

That will result in additional investment in other income of approximately $15 million per quarter and that will be offset in the income tax expense.

So these two transactions will increase the lower end of the previous guidance range for this line item by approximately $10 million so we see investment and other income to be in the range of $90 million to $100 million on a go-forward basis.

In terms of net interest revenue in the second half of this year, we are also planning to reduce our exposure to interbank placements assets so actually reducing the amount of cash that we have there and increase our securities portfolio inventory of high quality liquid assets.

The anticipated revenue as a result of these tactical actions should mitigate the impact of our net interest revenue as a result of the ECB interest rate actions as well as this prolonged low reinvestment rates in the US.

Severance charge this quarter will benefit our expense run rate beginning in the second half of the year.

We expect the savings of our streamlining actions to more than offset the impact of the July 1 merit increase.

As mentioned earlier, we expect our headquarter sales to close this quarter.

In terms of financial impact, we will see incremental occupancy expense of $30 million in 2015 as we absorb the rent expense on the new headquarters as well as the expense of transitioning out of 1 Wall Street.

Once we do make that transition and get through the overlap, we expect to see a benefit of our expense base of approximately $10 million in 2016 and beyond and that is versus staying here at 1 Wall Street.

In addition, the proceeds will enable us to pay down nearly $500 million of long-term debt and we will also receive some benefit from tax incentives provided by the State of New York.

We intend to continue to buy back stock in the third quarter based on the market conditions.

We expect the tax rate to be around 27% for the quarter.

Our focus has been and will continue to be on executing to drive shareholder value.

As Gerald said, we are not relying on market activity to improve.

We are continuing to identify ways to increase our efficiency and we are working to ensure that the actions that we have taken continue to show up in our numbers.

With that, let me hand it back to Gerald.

Great.

Thanks, Todd.

Wendy, I think we can now open it up for questions.

(Operator Instructions).

Ashley Serrao, Credit Suisse.

Good morning.

Gerald, you just come off a sizable expense program.

You recently announced for the expense initiatives, they are supposed to begin the second half of this year yet you found some levers to pull this quarter as well.

So my question is what else are you evaluating today, how quickly can you deliver and should we expect this 4% year-over-year decrease to actually build going into the back half of the year?

Or is there some investment spend to take into consideration as well?

Thanks, Ashley, for the questions.

We continuously look at all of our expenses as a way to try to control them better and recognition of the macro environment that we are in and rightsizing the size of the Company to the reality of the revenues that are being generated.

So it is a continuous process.

That is why we haven't announced any program, we haven't announced any separate initiative.

It is day in and day out reducing expenses and improving our operations and efficiency.

I feel good about what we have achieved so far in the first half of this year.

We are looking to do more in the second half.

The severance costs that we are taking this quarter, the run rate will improve and offset the normal merit increase in the second half of this year.

So I feel good about going into the second half in terms of continuing to control expenses well.

Got it.

And then can you remind us of what your ROE and ROTCE targets are and give us a sense of where you think you can go without any help from rates and how quickly you think you can get there?

Yes, we had indicated a few years back that our target on ROE was about 10% and return on tangible common equity would be substantially higher than that so for the first quarter -- excuse me -- for the second quarter, return on tangible common equity was about 18%.

We think we can continue -- in the first-quarter, we are going to be around 8% and 18%.

We think we can continue to grind that up into that 10% range without a significant move with rates or volatility.

Obviously if we saw a move and better market conditions here, then we would see a much more significant jump.

All right, thank you for taking my questions.

Alex Blostein, Goldman Sachs.

Thanks, guys.

Good morning.

A quick follow-up on the numbers I guess on expenses and then a bigger picture question after.

So lots of moving pieces.

You guys announce additional measures and you just highlighted obviously some of the benefits will come in next six months or so in comm.

But I guess if you look at the expense base overall, $2.7 billion-ish run rate in the quarter today like ex some of the one-timers, is that a fair run rate?

Do you expect to grow that as the business continues to grow or is this kind of the run rate in expenses we should think about over the next six to 12 months as you realize some of these savings albeit offset by some of the growth initiatives?

Alex, it is Todd.

We are working real hard to try to maintain this expense level or keep it from growing so that the actions that we've taken around the headcount, the actions that we've taken around occupancy, the very careful analysis of all of our discretionary spend, we want to try to keep overall expenses flat.

And some of the benefit of that we are using to invest in some of the new revenue streams that Gerald has talked about.

But all in all, there can obviously be some noise in those numbers.

We are trying to keep it a flat as we can.

Got it, that is helpful.

The second question just on the current environment.

Over the last three to four months or so we are seeing increased pressure on the bigger banks to shrink the balance sheets to get faster compliance with SLR.

You see that resonating in the repo markets declining 10%-ish or so year over year.

Just curious to think about how that impacts your business holistically.

You guys are obviously a big tri-party repo manager.

Just curious to see how that flows through to your operations?

And just overall given the fact that you are a big counterparty to a lot of the banks on Wall Street, is that having any sort of impact on the business overall?

Alex, great question.

Certainly some of our largest clients are shrinking their balance sheets and reducing their repo positions and what is interesting is our tri-party repo program has essentially been flat so as the dealers in the US have shrunk the marketplace, the global tri-party program has increased so we are able to maintain the revenues and the profitability in the business and get a good return on the investments we have made in the tri-party repo reform program.

There is no question that as the big dealers in the US shrink their activities, there is some impact on our revenue stream there.

But we are making up for it through enhanced services and capabilities in other places like collateral services.

Collateral services as you may recall was originally designed for the sell side.

The buy side is the one that is going to start using it much more heavily and so we feel very good about our position in being able to offset the declines in the large broker dealers with more activity from other clients.

Got it.

Great.

Thanks so much, guys.

Betsy Graseck, Morgan Stanley.

Two questions.

First, on the corporate trust, you indicated that you went through the review and decided to retain it.

Could you just give us a little bit more color on the ins and outs into that decision?

Sure, Betsy.

Thanks for the question.

When we said in May when we made more public that we were exploring this, we said at the time that unless someone was willing to pay us a premium value for this business, we wouldn't sell it because we like the business, we like the attributes of it, it is a fee-based business.

It has future upside potential with a more normalized monetary policy and as structured notes and mortgage-backed securities come back on, we see light at the end of the tunnel.

We would only sell it if in fact someone would pay us the premium what we thought the value of this business was worth.

It is a challenging environment for someone to acquire something of this size and complexity and so we decided that we couldn't get the kind of premium that we thought this business was worth and we think it is much more valuable in our hands and we can continue to build upon it and leverage it and it is a great business.

That is why I said we have always liked it.

It was only a question of whether it was more valuable to someone else than versus us.

Okay.

So obviously the Street knows that there is an increased activism in the Company and I guess the underlying question is was this undertaken in part to answer questions to those folks or were you able to get to higher ROE or ROTCE expectations via the work that you are doing now on the expense side?

The consideration to begin with, started a long time ago so let's start with that.

Our Board has always been very active and we as a management team have been very active in looking at all of our portfolio businesses and making sure that they are best held in our hands versus someone else.

And on corporate trust, in some ways it was a simple math.

In a low interest rate environment with the level of deposits that were generated, if someone could make better use of those deposits and get a better margin on it and pay us a premium for the business, that is when we would consider it.

To the extent that someone couldn't take advantage of it, we are happy to have the business and continue to own it and grow it and it is a leading market share business.

So that was the core reason for that.

We think we can achieve our capital ratios, our leverage ratios, our liquidity coverage ratios all within our own means irrespective of retaining the corporate trust business.

Got it.

And then just separately kind of ties into the collateral management question earlier, but as the Fed ends tapering and then starts to increase the reverse repo program, obviously you are in the middle of that and with money market funds management product you have got as well as with the tri-party exposure that you have got, maybe you are in a unique position to give us some color on how you think that higher increased RRP program is going to impact the financial markets?

I will start with part of the answer and then I will turn it over to Todd.

Todd has become a student of this as well as Curtis.

We are the vehicle through which the reverse repo program of the Fed is -- we are the mechanism for allowing it to happen in the marketplace or for them to put the program in place.

So the Fed is a client of ours in that regard and so we do see the activity running through us and we are not going to violate any confidences there.

But I think it is certainly one of the tools in the Fed's toolbox in terms of managing monetary policy and interest rates and so maybe with that I will turn it over to Todd or Curtis.

I would just add that given the new liquidity and capital rules, it is going to be difficult for the Fed to do open market transactions the way they have done in the past, hence the reverse repo program where they go directly to money market funds, it came into place.

I think there is some question about just how much the Fed wants to expand that program and obviously if they do expand it, they would do it through the tri-party repo so we do see that activity.

The other alternatives that they have to increasing interest rates or a drain is to either sell some of the assets that they have or increase the interest rates that they pay on excess reserves or on this term deposit facility that they have in the banking system.

So if they do reverse repo, the cash will come out of the banking system and it will go into money market funds based on price and then the banking system would have to bid against that.

Some of the cash that went into those funds would come back into the banking system but I think it is kind of that simple.

As reverse repo grows, the excess reserves should decline.

Glenn Schorr, ISI.

Hi, thanks very much.

So the actions that you described taking to offset some of the lower rates and the actions in Europe, I am curious if you feel that has any material change on your asset sensitivity once all the changes are in motion.

I heard you on the revenue neutrality but just curious on what that means in the rising rate environment in the US?

Yes, as you can tell from our NIR and our position, we have taken a bit of a defensive stance.

We have actually reduced our asset sensitivity substantially from where we were last year.

We do pay for that a little bit on our NIM, there is no question about it.

There will be a little bit of an increase as we do make that transition, Glenn.

I don't think it will be significant.

It will be in the vicinity of about 10%.

So our sensitivity would increase about 5% to 10% and we will be users of the held to maturity account as well so there is less sensitivity to the capital ratios.

Got it.

Okay, cool.

And speaking of capital ratios, just looking for a drop more color on what specifically got consolidated from asset management to produce the drop in the ratios?

And I'm just curious on timing on why it happened this quarter.

I'm just not familiar with it.

Sure.

We actually consolidated some of the CLOs that one of our asset managers managed -- actually quite a few of the CLOs -- so as we transitioned from Basel I to Basel III, we actually reviewed the treatment of those consolidated assets and we determined that even though we have no economic risk to them, we have no credit exposure at all, that they should be included in our risk-weighted assets.

We actually expect this might be a temporary item.

FASB has just recently discussed the possibility of adapting a new standard that could be adopted as early as next year and it would lead to us probably deconsolidating some or even most of these assets as early as next year.

Okay.

Last one for me is just the 24% decline in business development cost.

Is there a business component to it that impact or is that more of a sustainable decline because it actually -- it really moved the needle?

Yes, there are two major components.

There are a couple but I would say the two major components in there, Glenn, is our marketing expenses and our travel and entertainment expenses.

We have been much more of aggressive in managing those discretionary expenses.

For example, we have discouraged internal travel.

We have encouraged increased use of video and audio conferencing.

And so rather than pull some of our operating committee together from time to time, we are doing it virtually much more frequently and we are doing that across the board.

We are not decreasing important revenue producing travel.

This is internal related travel.

Also last year we had a substantial campaign on our marketing and branding efforts and we reduced the spend associated with that.

We are going to try to keep this discipline and sustain these levels.

Now there is some seasonality to this with conferences and so forth so we would expect the third quarter is typically pretty good and the fourth quarter tends to be a little bit higher.

Okay.

Thank you for all of that.

Ken Usdin, Jefferies.

Thanks, good morning.

Todd, one follow-up on the NII, outside of the puts and takes, can you also tell us whether or not you think you can actually maintain this current level of NII?

Your comments were more focused on the offsets between extending versus the drags from ECB but what is going on underneath that surface?

Yes, I think we will be able to, as we model this out and obviously it is going to be a bit sensitive to interest rates, but as we go through our modeling here I think in the next few quarters we will be able to maintain the level at this rate or in the ballpark of this rate, maybe slightly higher.

Okay.

Two questions on investment servicing, just core asset servicing ex securities lending was up only slightly sequentially but it was up 4% year-over-year.

I'm just curious if you can walk us through trends underlying the asset servicing.

You did have AUC growth and I get that you are not as much of an equity sensitive custodian but only a $5 million kind of core increase in servicing.

Can you give us some flavor for the growth or the traction of growth that is underneath that?

Ken, it is Gerald.

Just a couple of comments there.

One, you will recall we did lose a couple of clients over the course of the last 12 months.

Those losses are now in a full run rate and that is why you've see a softness in some of the asset servicing revenues.

That is now fully in the run rate and we think we feel good about the pipeline in the go forward.

We are attracting good clients and so it is a little bit soft this quarter but we expect it to pick up in the future.

Okay.

My last one just about the issuer services and you point out the drags of both sides of the business but the second quarter is typically a seasonally stronger on that leads to the bigger jump in third.

So can you also just walk us through corporate trust and ADRs and the drivers there?

Sure.

So issuer services on a year-over-year basis I think it was down more than $60 million.

Part of what we saw in the second quarter was last year we saw a little more dividend action in the second quarter and due to timing we are going to see some of that in the third quarter so we would expect the third quarter to show the typical balance that we get and seasonality around DRs, probably a little bit higher than typical.

So that was one of the reasons for softness.

The other reason is we also had fewer of these kind of pass-through where some of our technology investments in corporate trust have paid for clients and we see that in revenue as well as in an expense line.

We had a little bit less of that.

Okay, great.

Thank you.

Mike Mayo, CLSA.

To as you say, reduce structural costs, maybe you need to further reduce the structure and at the annual meeting, I asked about the merits of having both asset servicing along with asset management.

And Gerald, you said that you have done the work and my thought is perhaps you need to show your work because the way we look at it the reported ROE has not been over the target of 10% since at least 2009.

And so if this is a superior structure, shouldn't there at least be an ROE in the double digits?

Mike, just as I said at the shareholder meeting, it is a business we like a lot.

We think there is a lot of good benefits with the two businesses together.

Investment Management is a great contributor to our earnings, it is capital light.

It is fee-based.

We are getting collaboration across the businesses, we learn from each other.

We are collaborating on new products and new services, new capabilities.

When we have done the math, as I said at the annual meeting, we don't think the math works.

There is a lot of tax challenges, a lot of regulatory challenges associated with it.

We are in fact improving the margins both in Investment Services and in Investment Management.

That was evident this quarter.

In Investment Management, you saw a 2% improvement year-over-year in the margins in the business while we are still investing in it.

So we think we can improve the returns and the margins and drive a great business together.

We like the diversity of the earnings.

We like the fact that they mutually service the same client.

I think it is a great combination.

I have three follow-up questions.

Should I ask one and then requeue or ask all three now?

Ideally one now and then requeue, Mike.

Okay.

So what is the dollar amount of synergies?

And to repeat what I said before, again if this is such a good combination, why has the ROE been below the cost of capital for the last five years?

So, Curtis, maybe want to touch base a little bit on some of the synergies.

So, Mike, I think that when you think about Investment Management, we are serving the same clients in so many cases that are clients in our Investment Services business.

You have asked for a very specific number.

Truthfully what ends up happening is these clients become clients of both parts of our organization but it is this continuous ability to connect to the Investment Services clients that is such a powerful part of the Investment Management.

Let me give you a -- just in this quarter a couple of examples.

We had a foundation, a client of the Investment Servicing business that expressed an interest in expanding their portfolio in a direction of direct lending investment vehicles.

The team that covers them from Investment Services was well aware of our capabilities in this space, introduced us to that client and it became a win for us in terms of gaining an Investment Management mandate.

Another part of the Investment Services business that has been a real winner for us in the past several months has been offering our private banking services to the clients of Pershing.

So the financial advisors that Pershing serves, many of them don't have access to their own private banking activities so we have linked those two -- actually invested in having a team in our private bank make lending available to them and have seen nearly $0.5 billion of loan volume over a pretty short time and actually on really what we call the pilot effort that we are now actually expanding to make it a much bigger part of the business.

If you look at our cash business today because we are at a low interest rate environment, the overall economics of the cash business are not nearly what we think the contingent opportunity is in a more normalized rate environment.

But just think about all of the changes that occurred in the money market fund world.

The question was asked earlier about the basic change in market structure.

We think we are very well positioned to provide services around cash products and in a higher rate environment, that will be very valuable to the shareholders of BNY Mellon.

So those are just some examples of the places where there is real synergy.

Okay.

I will requeue.

Thanks.

Brennan Hawken, UBS.

Good morning.

So I guess -- I am a little bit confused about why you would want to give up your asset sensitivity or lose some of the asset sensitivity here.

I mean the NIM currently at roughly 100 basis points is far from heroic.

You have got Yellen making comments that rates might be moving higher.

So can you help us understand what drove that decision a little bit with a little bit greater clarity?

So you are talking about moving a little bit of the cash that we have in the form of placements into high-quality liquid assets.

Part of that is compliance with LCR, so we are sitting on a massive amount of cash.

Placements are not LCR compliant, so this is a fairly easy way for us to comply, and we will generate a little bit of additional NIR.

We don't want to give up much of our interest-rate sensitivity, so you are not going to see a significant move there.

We do think that there is both an opportunity cost and a capital cost to doing that, Brennan, but you will see a modest adjustment.

Brennan, some of the other activities we are working on, you have seen the loan book in our wealth management business grow.

We like that asset.

You see some of our secured financing for some of our collateral management clients increase.

We are looking at other areas within our asset capabilities to generate better returns on those assets and still keep the interest-rate sensitivity available to us for when rates do improve.

Okay.

Thanks for that color.

And then if we think about your asset management business and the sort of adjusted pretax margin there, if we look at what happened last year in that business, it contracted about 100 basis points versus 2012.

And I understand the majority of that was investments and distribution.

But if we look at other asset management firms, they saw a rather significant expansion in margins last year.

So I guess what is holding back the asset management business, given how constructive the market is?

Is there a structural impediment there?

Does it have something to do with how the agreements with the affiliates are structured?

If you can maybe help us understand that a little bit, that would be great.

Yes, Brennan; it is Curtis.

First of all, I would say that last year in addition to the investments that we made to grow our wealth management business, to expand our reach to financial intermediaries, financial advisors primarily in the US through Dreyfus, and also to grow geographically; those investments, they certainly dampen margin.

But I also would call out the fact that we had a pretty meaningful fee waiver environment.

So we have -- a big part of our business is absolutely impacted by low short rates.

When you compare our overall enterprise to other peers that are sort of over the $1 trillion mark, we have a substantially smaller percentage of assets that are in the equity asset class.

And I would also point out that our equity AUM is also pretty diversified, a lot less as a percent of US equities, which had an especially good year last year.

So while it was certainly a tailwind for us, it was not nearly the tailwind it would have been for investment firms that are less diversified and more singularly exposed to equity AUM.

I don't think that the boutique structure -- certainly each one of our investment firms is very focused on their client base, their asset classes.

They have a wide array of their own activities both institutional and through retail distribution channels.

But I actually think that they benefit from the scale.

We have firms that are 30, 40, 50 people highly focused on a very specific asset class and we give them geographic reach in terms of clients.

And we have a firm on the East Coast of the United States that is raising money all over Asia and throughout the Sovereign Wealth Fund world without having to actually build their own structure to do that.

We are pretty excited about it.

We are investing in it and we are absolutely focused on improving margins.

It is why we are investing where we are.

If you look at the peers who have higher margins than us, they generally have substantially larger percentage of their assets in the retail space and they have a larger share currently.

They are benefiting from the equity tailwind.

Of course that creates more profit volatility and margin volatility if you look at it through time.

But we are investing to improve our margins and are pretty excited about our opportunities there.

Just one final bit of color.

I think you are seeing evidence of it in the 200 basis point improvement in margin year-over-year.

This year and early next year are sort of the high watermarks in terms of the level of investment.

We showed you in April the expected improvement in margin as those investments start to pay off.

And also might add the investments we are making are not high risk investments.

It is investing in wholesalers and distribution, it is investing in wealth managers.

We are bringing in clients.

It is starting to show up in our numbers now so these are investments we have very, very high confidence on the return.

Okay.

Thanks for the color.

Brian Bedell, Deutsche Bank.

Great.

Thanks, good morning.

On just back to the corporate trust on the expense side of this, so can you just talk a little bit about to what degree some of the consolidations of those platforms were involved in the prior cost reduction program and whether that dynamic changed upon your decision?

And then so should we be thinking about any other further back-office consolidations as a potential expense save on the corporate trust now that you are keeping it?

Yes, the primary operating platform for corporate trust is a trust accounting system and it is really dedicated to corporate trust.

They are the last users of it and actually we were in a migration mode to our in-state platform called GSP for those of you that are interested in acronyms.

We were in the process of doing that conversion.

We are going to continue that process and it should be completed next year.

So there is no change in that going forward and we will realize better operating metrics as a result of it.

So that -- so yes, (inaudible) change to your expense view based on you keeping that?

Brian, you are breaking up.

If you could say that.

No change in the expense view based on your keeping that is the takeaway there.

No, not at all.

And then on the revenue side, maybe a question for Curtis and Brian.

Congrats on your expanded roles by the way.

On the clearing business, the revenue held up well given DARTs definitely declined in the quarter so was just wondering if that was due to the component that is related to licensing and asset management?

Or are you gaining new clients and is the run rate better there?

Similarly for Curtis, the organic growth has been very strong on asset management recently; this quarter a little bit weaker.

Maybe if you could just address the LDI outflow and your view of sort of organic growth coming in the next one to two quarters overall.

Brian, it is Brian Shea.

I will start with the clearing question and then I will turn it over to Curtis.

The clearing business has been pretty solid with core fee growth driven by significant growth in mutual fund assets and asset-based fees, offset by higher cash management fee waivers and lower DARTs as you recognized.

I think the underlying metrics behind the clearing business are all really pretty strong and this quarter we have a record level of client assets in custody.

We have a record number of total individual investments on our platforms globally.

We have record levels of mutual fund assets on our platform overall -- and growing margin balances as you can see in the metrics year-over-year.

And despite lots of low rates and discussions about money market industry, pretty solid cash management balances.

And I would note actually to reinforce Curtis's point, that the market share, Pershing clients choosing because they decide which cash management alternatives they use, but the clients have chosen Dreyfus more than ever before and so we have a record level of market share of Dreyfus cash management on the Pershing platform.

Again, when an interest rate environment changes, that will be a much more valuable linkage and synergy between the Investment Management and Investment Services business.

So that is my perspective on clearing.

And I will turn it over to Curtis.

On the organic side first of all, I would tell you that we had long-term outflows this quarter of $13 billion.

It is a pretty unique situation actually in that one of our large LDI clients actually decided to take their LDI activities in house.

So it was not in any way related to our investment performance or our service.

We always hate losing any business but completely understand the decision that they made to do that.

I will tell you that our pipelines around LDI specifically continue to be robust.

Pension de-risking is still very much alive and well and I would actually say is expanding geographically.

So our largest business is Insight, which has a large book of UK LDI business and I can tell you that the global interest in LDI is definitely not shrinking.

One of the nice things I will tell you about Insight -- the tools that you have to be able to appropriately model the liabilities especially UK liabilities that have an inflation sensitivity component, you have to be very good at understanding market dynamics and what drives risk and return.

And in the quarter, Insight specifically actually had a very significant amount of inflow into alternative strategies, absolute return strategies where they are taking a lot of their capabilities and creating absolute return products that their clients who have been very satisfied with them in the LDI space are allocating money to them and also getting broader interest.

On the short-term side, like the rest of the industry we did experience outflows.

Our outflows we think are roughly in line with what the industry saw in the second quarter both -- some of it being tax payments, some of it being the clients were certainly in the beginning of the quarter reallocating out of short-term cash into somewhat higher-yielding assets and actually that is the story of fixed income as well.

Our outflow there is related to mostly short duration fixed income where clients are reallocating.

In equities, the dynamic there has really been three things.

The equity rebalancing so the increase in equity markets has caused clients to move money but we've also seen clients move assets around into asset strategy.

So in this quarter, you actually will see our increase of $7 billion was almost entirely equity index.

So it is nice when you have a diverse range of products to be able -- it is leaving one place, it is going another -- money in motion is a big part of our advantage here.

Great, great.

Thanks very much for the thorough answer.

Cynthia Mayer, Bank of America, Merrill Lynch.

Thanks a lot.

So just getting back to the expense management, you and others have been mentioning for a while the pressure of compliance costs.

And I am just wondering looking ahead do you see those leveling off?

Is that a pressure that you feel is abating so that to the extent you do streamlining, more of it will fall to the bottom line?

And the same question on I guess the combining of your platforms, is there upfront IT for that?

Great question, Cynthia.

So first on the regulatory side, the rate of increase is slowing down.

It is creating greater clarity around the rules and the regulations and what we need to do to be in compliance with them.

But importantly, we cannot sacrifice having a well-controlled well risk managed firm.

We are absolutely committed to that and we are not going to sacrifice having a great firm in those categories.

We do in fact see the rate of growth moderating and our expense management is taking into consideration continuing to fund those activities.

So that is why we are very diligent around all the other things that we can control so that we can fund new investments, we can fund having a well-controlled environment and continue to grow our businesses and serve our clients well.

So it is all factored into the expense control programs that we put in place.

On platform consolidations, again, the technology investments that we are making are factored into the expense base and we are realizing the synergies that are the platform consolidations and it is in the run rate.

Okay.

Thanks a lot.

Everyone, thank you very much for dialing in today.

I know we had a lot of interest in our results and so any follow-up questions to Izzy Dawood or Andy Clark are available to answer your questions and thank you for your interest in us.

Have a great day.

If there are any additional questions or comments, you may contact Mr. Izzy Dawood at 212-635-1850.

Thank you, ladies and gentlemen.

This concludes today's conference call.

Thank you for participating.