花旗銀行 (C) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, welcome to Citigroup's Second Quarter 2003 Earnings Review.

Featuring Sanford Weill, Citigroup Chairman and CEO, and Todd Thomson, EVP of Finance and CFO.

Today's call will be hosted by Sheri Ptashek, Director of Investor Relations.

We ask that you hold all questions until the completion of the formal remarks, at which time you'll be given instructions for the question-and-answer session.

Ms. Ptashek, you may begin.

Thank you, good morning, everyone.

Thank you for joining us today.

Sandy's going to spend a few minute with us talking about the highlights of the quarter, and Todd will take us through the analyst presentation and we'll be happy to take your questions.

With that, let me turn it to Sandy.

Sheri, thank you very much.

I think that we really had a very good quarter and, especially when you think about the fact that our revenues were up 8% and in a very slow economic environment, not just the United States, but in Europe, Japan, and lots of other parts of the world.

And I think that we feel great about the fact that our profitability was up 14% based on that 8% increase from revenues to 83 cents a share or 4.3 billion after taxes.

These are GAAP numbers and they will be feeling good about that, and we think that the outlook for the second part of the year going forward is also beginning to strengthen, and we think that is happening for several reasons.

Number one, we see a steadying and -- in our -- what is happening on the credit side, both from the consumer and in the corporate side and some of the leading indicators point to improvement in that which, Todd, um, will take you over, as well as our seeing an increase in our backlog of expected deals and an increase in M&A activity which says that people are beginning to think about getting back to business.

We also feel great, and it's a different kind of a number that we looked at our equity increasing to $100 billion at the end of the quarter.

That is common equity plus trust preferred.

And, again, we want to run that business without over-leveraging our balance sheet to make our earnings, and we think again that we did that in the quarter earning over 19% return on equity. 19.2% in an environment that really, again, was not so good.

I think what I feel great about is the President's change in the tax law and reducing the dividend, the tax law on dividends to 15%, which we have been saying if that ever passed would encourage us to look toward paying out more of our earnings and dividends and moving some of that money away from what we had been doing in buying back stock in significant numbers with our pre-cash flow over the past several years, and I think to really make that point, we raised our dividend this morning for the second time this year.

The first was from 18 to 20 in February's payout, and here, increasing at 75% so that we are beginning to give shareholders a more meaningful part of our earnings in dividends.

But when you look at it on a calendar year basis, our payout this year will be something like a third of our -- or what you all think our expected earnings are for the year, which is still not at a very, very high level.

I think that, again, some of the reasons that we are doing well as I think we have a fantastic management team in this company, and it's a team that really has come together and is working together and helping each other and that really makes a difference.

I think when you look at some of the things that we have emphasized for a long, long time, like the great majority of our earnings comes from returning and predictable sources and we see the advantage of that in difficult times, also that our sales and our profitability comes from a very diverse set of products as well as the income coming from all different geographies from around the world.

That also gives us a big advantage.

Finally, our business model.

Our business model really works.

We can do more for our customers, whether those customers are government, whether those customers are individuals, or whether those customers are, are corporations, and that is really beginning to work on a totally, on a global basis.

We mentioned in our press release this morning that we are switching some of our option-based compensation to restricted stock.

I want you all to know that that's not copying Microsoft.

We announced that to our employees over a year ago, and June 30, we offered restricted stock to 95,000 of our employees that the previous June 30 had all gotten options, so we were on the category quite awhile ago, and as we think about options in the future, we do have, and we think very important from the corporate governance point of view, that our ownership be long-term, and you all know that our senior managers, which is like 130 people, have to keep 75% of what they get, but everybody who exercises stock options has to keep that stock for two years beyond the date of the option exercise, so it's not exercise themselves.

But having said that, we are going to be much more restrictive in the future and the number of options that we give out so that I think we would be thinking of somewhere in .5 to .7% range for our options as it relates to our total capital, which would be down, you know, from half of where we were a few years ago, and I think much more a better way to think about really making options an extra special reward.

I think also we got the message on reputational risk, and as we think back about all the things that happened over the last year, which hurt the reputation, not just to our company but of our industry, I think that it became important we react to that and we have done a lot of things in the area of corporate governance in making our business and working toward creating more diversity in our business among the people that we have, and we're glad that that was recognized by "Fortune" magazine.

We're one of the top 50 in that.

We have been working on the environment in a very serious way, and we're proud to be one of the original sponsors of the Equator Principles, which I think will really work toward what we do and in structured finance, and financing those kinds of transactions around the world where the environment will become an important part of what we do.

I think when we talked about our outlook and we are feeling better about the outlook, not just in the United States, but I think we're beginning to see the beginning signs of movement in the countries like Germany and France, toward pension reforms, toward thinking about a lot of the issues that they have with their workers that create a lack of flexibility for companies, I think it was important that the unions in East Germany were turned down in their quest for a 35-hour workweek when the number of unemployed people there were really at a very, very high level so that I think we are beginning to see the beginnings of some things possibly even happening in Japan.

So, I think when we think about our business going forward as I said at the beginning, I think we feel good about it.

So with that, I'm going to turn it over to Todd who is going to take you through all the numbers, the specifics on our credits what, we have seen in the trends getting better.

I think we -- getting to like reporting strictly on a GAAP basis, which includes everything, and we really appreciate everybody's support and we look forward to continuing to deliver in the future.

So thank you very much.

And, Todd.

Thank you, Sandy.

Though exceptional financial performance this quarter, obviously the backdrop was a lot of inconsistent economic data that probably is consistent with what looks to be a gradual stabilization in the early stages of a recovery.

On the positive side, we saw the best quarterly performance in the S&P 500 since the first quarter of '98, capital markets volume picked up substantially in the first quarter, high-yield debt was up 93%, equity up 113%, M&A was up a bit, and trading volumes are up.

The average daily trading volume was up 15% versus the first quarter and up 3% year-on-year.

On the negative sides, some of the negative indicators, unemployment was up a bit to 6.4%, which is the highest level in awhile, although employment still remains strong, and bankruptcies hit a record, up 9% higher than last year.

Consumer confidence has been volatile.

So, we also saw in that backdrop, another 25% -- 25 basis point reduction in said funds and significant volatility interest rates as the markets try to sort out between the risk of inflation, the risk of deficits and the likelihood of the economic recovery.

You saw the 10-year begin the quarter at 380, bottom out at 310, and it's currently about 360 today.

And spreads narrowed substantially, which is the indication that the credit is going to get better going forward.

Mutual fund flows and fixed-income flows are very strong during the quarter as well.

So, in what appears to us to be a firming economic environment, we continue to have exceptional financial performance.

Record income, $4.3 billion after tax.

That's $200 million more after tax than we have made before, the previous record was last quarter.

EPS up 14%.

I'm going to talk in a minute about the dividend increase up 75% to 35 cents a share.

And, obviously, as you have seen from our numbers, the consumer income was up 18%, $2.3 billion, very strong performance there, but also very strong performance for our corporate investment bank, which once again ranked number one in debt and equity underwriting, and we had a record quarter for fixed income underwriting revenues of $500 billion or up 41% and continue to deliver return on equity of close to 20%.

Let me talk for a minute about the dividend increase of the next page of the presentation.

As Sandy had previously mentioned, we increased dividend 75% to 35 cents a share.

So for the first two quarters it was 20 cents a share, we're paying out.

The next two quarters, it will be 35 cents we're paying out.

That would give us a payout for the year of 33% on the First Call expected yearly earnings.

If you annualize that 35 cent number, we would have a payout of about 43%.

It was 42% this quarter.

That puts us sort of middle of the pack with the bank.

So we felt that as you can see on the right-hand side of the chart, whereas in the last five quarters if you took the average, we spent $2.3 billion between stock repurchases and dividends.

Mostly stock repurchases.

This quarter, we would be spending $2.2 billion, a billion 8 now for dividends and $360 million that we did in the quarter for share repurchases.

So, essentially the same amount of money as we have on average for the past five quarters, but the mix changing dramatically more toward dividends.

We also, as Sandy mentioned, I just want to re-emphasize this, we announced we shifted some of our equity-based comp to restrict some of our options, that really reflected what is called the Citigroup ownership program.

We made that decision a year ago where for the -- since 1997, this is for every employee that makes under $100,000.

There are 90,000 of them.

Every employee making under $100,000 gets equity comp.

Since '97, that was paid in option, and we made a decision last year and paid it in June 30, restricted stock instead.

Doesn't necessarily reflect the change of the general options program, although Sandy mentioned our thinking on that.

Let me move to the numbers for the quarter.

Page 4 there, revenues up 8%, and that was really good across each segment.

Consumer revenues were up 9%.

The GCIB, Global Corporate and Investment Bank were up 7%, investment management revenues up 8%, and only the client services segment had declining revenues.

Theirs were down 7%.

Our operating expenses were up 9%.

I want to spend a minute on the operating expenses as well, because obviously that's a relationship where expenses are growing faster than revenues, that we don't like and we're not used to, but I want to explain where some of that comes from.

Credit was pretty benign in the quarter, and we continued to focus on the tax expense lines.

We kept that about flat, so income up 12%.

By segment on the next page, we talked about consumer and corporate being up, private client and income was down 19% from a year ago, but up from last quarter beginning to see some better activity in the retail brokerage business there.

Investment management up 16%, and I'll talk a little bit about what is driving that in a while.

Proprietary investment activities was negative last year, and we had a slight positive this year.

We have been realizing gains as we have been selling out of the public positions of the venture capital portfolio that we had, and we had a nice move in the Nasdaq during the quarter.

So that was positive.

Mostly driven by realized gains.

And then in corporate other, we continue to see the benefit of low rates in the [STPU] curve, and we did repositioning in the quarter that I will talk about in a minute that will reduce some of that benefit going forward.

Below the continuing operations line, you can see in discontinued operation last year there was $255 million of earnings that we received from the 77% ownership that we still held in Traveler's Property Casualty before we spun them out.

And so on a net income basis, the number for the quarter, $4.3 billion remains the same, but the increase is lower because we had those earnings last year from TAP, and we have since spun that out to the shareholders.

For the first half of the year, we have made $8.4 billion after tax.

That's up 15% up 16% on an EPS basis from continuing operations.

And, again, strong performance for each segment.

Consumer up 21%.

Corporate investment bank up 12, and investment management up 13.

Let me move to a little bit of commentary on each one of the businesses within the segment, starting with cards, cards was up 6%.

Pretty strong performance to North America up 9%.

International was down 7 but I think that belies the actual strength we're seeing in international cards.

Most of that swing was a year-on-year swing for Argentina, and if you look at the Asia cards business and the Europe cards business, it looks quite strong during the quarter.

On the consumer finance side, clearly some difficulties in both North America and internationally.

In North America repositioning that a bit, we had new leadership coming into the business, and we're re-pricing a few of the products out there, but we would expect to see that business begin to get some more momentum toward the end of the year.

Credit does remain relatively stable there.

That's the good news.

The real story here is international where Europe was quite strong but Japan continues to be a very difficult situation.

Loss rates have been moving up as a result of our increase in the underwriting and reducing some of the marketing, the portfolio has actually been declining month-on-month since the beginning of the year and we now feel more confident with the operations that will start remarketing again.

I would expect this to be the -- the weakest quarterly performance for the operating part of that business.

The Lord works in mysterious ways, and in the quarter, we did have the tax settlement with the Japanese authorities for that business, and that resulted in, since we had reserved more than the settlement with the authorities, that resulted in the release of $94 million, which is an after-tax number, since it's a tax release in Japan, and that benefited the numbers in international consumer finance.

In retail banking, just a terrific quarter, up over 60% and the story was both North America international, very strong performance internationally in Europe as well as, especially in Asia, quite strong performance in Asia, and very good crop sell of investment products going on in Asia.

That looks quite strong.

In North America, we're benefiting from having now Golden State in the fold that integration went, dare I say flawlessly, and in addition to the Golden State benefits, the mortgage business has been having an absolutely terrific quarter and first half of the year, so that's been helpful as well.

The mortgage pipeline continues to be strong at nearly $30 billion as of the end of the quarter.

Corporate investment bank in capital markets and banking, investment banking revenue was a billion dollars, is up 4%, driven by debt underwriting, up 41% to just over $500 million.

A very, very strong performance there, and we moved to number one in high yield.

High yield already in the first half of the year exceeds the amount of market issuance of all of last year.

So it being number one, that has been quite helpful.

In equity underwriting, strong quarter from convertibles, down a bit from what was a strong second quarter last year, but up from last quarter.

And advisory also not quite as strong as an environment as we saw a year ago, but up from last quarter.

Trading revenue was flat at a billion 7, fixed income was up a little bit, and I do want to mention that in the -- in the trading revenue, we had about a $250 million swing year-on-year on credit derivatives.

We have credit derivatives as protection against our loan portfolio.

If you go to a year ago when we had our Worldcom issues and things like that, credit spreads were blowing out tremendously, that gave us some benefit on the revenue line a year ago, and this quarter, we saw credit spreads come in, continue to come in this year and came in significantly during the quarter.

So that swing of a positive last year and a negative mark this year was about $250 million on the trading line.

Equity was down from a year ago but again, up from last quarter.

And, um, FX was down a bit, and that was due to very strong performance last year on the FX line, based on some specific positioning we took in Middle East and Africa.

On the transaction services business, we're seeing good volume growth with liability balances up 14% and assets under custody of 4%, but with the continued reduction interest rates, we're seeing ongoing spread compression in that business.

Capital markets rankings on the next page, very strong across the board for the first half, we were one in almost all the fixed income lines, number one in debt and equity.

Again, this is the seventh consecutive quarter we have been number one in debt and equity underwriting, and the sixth consecutive quarter we have been number one in disclosed fees.

The strength there of that franchise continues.

We picked up strongly in the second quarter on equity and M&A, and so for the first half of the year, we're number three in equity.

Number two in announced M&A, number four in completed M&A.

Private client services down significantly from a year ago, down 19% on earnings, revenues were down 7, but up from $157 million of income in the first quarter.

Transaction volumes were quite strong.

We would expect hopefully that will continue and in addition the asset-based fees should be stronger in the third quarter as those will be priced off the beginning of this quarter as opposed to the beginning of the second quarter, where the markets were quite low.

Pretax margin of 20% continues to lead the industry with our margins, and net flows of $9 billion shows there is a strong continued strength in the customer franchise there.

Investment management segment on the next page, life insurance annuities continues to pay a difficult market environment.

You've got some competitors who we believe are pricing things at an uncompetitive level, so some of our volumes are down on the front end.

In addition, you're seeing continued pressure on investment yield, the low-rate environment, and, um, unfavorable adjustment to that, which we have spent a lot of time talking about previously that unfavorable comparison will continue the next few quarters until we get into a year-on-year flat situation.

So the net results of that is the operating business is down 25%, and then you can see we have broken up the line for portfolio gains and losses.

Last year, we had realized losses from the bonds of Worldcom that we had in our investment portfolio there, and so that was a positive pickup from the losses we had a year ago.

Private bank continued to have a very strong performance.

They are up 22%, very strong revenues, up 21%.

And business volumes up 10% to $180 billion.

So, continued to really outperform the competition in the private bank.

Asset managements revenues down and expenses down as we continue to manage the expenses in that business appropriately.

But very strong customer activity.

Net flows are up $8 billion, and AUMs are up 12% to just shy of $500 billion.

So, I think the customer statistics are strong, obviously suffering from the fact that people are mostly investing, have been investing in the first half of the year in fixed income rather than equities, and the equity markets have been challenged versus a year ago.

From the regional perspective, a very strong performance in Europe, held by the strong Euro, but also extremely strong performance for our corporate investment bank there, as market activity picked up and our shares picked up as well, and credit was in good shape.

Mexico continues to have a strong performance.

Asia, ex-Japan, the consumer business, there was up 25%.

So extremely strong performance in our consumer franchise.

In Asia, Latin America's bumping along, and you can see Japan is down 24%, which is driven by the consumer finance year-on-year comparisons.

Let's spend a minute on the next page on revenue expense growth.

Revenues were, as we mentioned, a record of $19.4 billion, up 8%, expense up 9%, and that's a $824 million increase over the prior year. 300 million of that is what you see on the page there, severance, Latin America repositioning, which are one-time items, um, but then there are some on-going head winds, which we will continue to face over the next few quarters, which is the stock option expense, which we initiated this year.

The increased pension, the increased legal expense, and then, of course, increase debt that we talked about.

Let me move to credit quality.

On the consumer side, overall indications are stable, and in-line with our expectations for the full year, so so far so good.

Bankruptcies were up 9%, and as a result, credit losses were up a little bit, but delinquencies continue to trend flat.

And all the mortgage refinancing that’s going on is obviously helping consumers stay liquid.

On the corporate side, losses were up a bit from the first quarter, but cash basis loans remained flat as a percent of end of period loans went up modestly in dollar terms from the previous quarter, and I thought it would be helpful on the next page just to show you how the losses have come in for the first half of this year versus the first half of next year, so I'm on page 16 now for those of you following along the presentation.

And as you can see last year in the first half of the year, we provisioned for $833 million of credit expense and it was 40% Argentina, another 40% or so in telecom, and then very small amount in merchant power and energy.

In fact, the only number we have is for Enron that we had last year.

Contrast that to what we see this year as expected.

Argentina is a slight recovery this quarter, but essentially zero.

Telecom losses are reduced substantially as we have, you know, provisioned for those primarily last year, and most of those have now washed through the system.

A few more to go.

And then the real issue has been power and energy and the first half of the year, which is 33% of our total losses this year.

But overall, we're running about half the rate that we were in the first half of the year.

We're increasingly comfortable that for the full year and for the second half, credit losses should be lower than where we were last year.

Our cash basis loans as we mentioned in the press release are up a little bit, up modestly.

I do want to talk a minute about our classified loans, the way we run our credit portfolios.

We classify each of our corporate credit loans.

And when they're classified, it's because we begin to get worried about them, and then they will move typically from a classified into cash basis loans if they worsen.

For the first quarter in several quarters, our classified loans in total have come down and they have come down relatively well.

Over 5%.

And, more importantly, the amount of those that are classified two or worse have come down as well.

And so we're beginning to see some firming and some improvement in our corporate credit book, and we feel -- we feel more comfortable, increasingly comfortable, um, that the year will come out better than last year in corporate credit costs.

On Page 17, there has been a fair amount of discussion and debate about what is going on with interest rates -- rates and people's relative positioning.

I wanted to highlight what we've done on our issuance program and our interest rate profile so far.

In the first half of the year, we felt that there was an attractive rate and credit environment and so we issued 15 billion, just under $15 billion of debt, which was prefunding of debt, what we would have to do for the full year.

We did that in four currencies, and given the low-rate environment, really historic low-rate environment, especially on the long end, um, we increased the weighed average maturity on what we issued to 7.6 years, versus the average for our book today, which is about five years, so we went to -- we prefunded and went a bit longer.

I want to highlight one particularly good transaction, which we did $165 billion of Yen in a five-traunch [INAUDIBLE], that's a fixed rate at 66 basis points, .66% fixed rate average maturity of seven years.

That would cost about 50% more than that today.

So that was quite a good issuance for us.

On the interest rate profile, we think about our interest rate position in the context of what is going on in the market and the credit in the business outlook, and not just in the context of that interest rate positioning.

And so, you know, typically in an environment where interest rates are coming down, they're coming down because the Fed is pushing them down because we're in a tough credit environment and a tough market environment.

And so, in that kind of situation, we clearly want to be positioned for that decline.

So we view that as a bit of a natural hedge against what is going on in the markets.

We believed a couple of years ago that we wanted to mitigate the risk of this type of environment as we could begin to see a slowdown in the markets and credit picking up, so we increased our GAAP at that point, and as a result of that, we have reduced our average cost of our debt outstanding by 150 basis points.

And that's reduced the present and future funding cost of the company by $7 billion at prevailing rate, so I think that's worked out well so far.

During the quarter, as you saw, such volatility in interest rates and we took advantage of that to reduce this GAAP a bit, so we moved down our interest rate profile or earnings at risk from 760 million to $450 million during the quarter.

And as part of that, we took off $13 1/2 billion of swaps, and that gave us a billion and a half gain that will get amortized that doesn't come in this quarter.

But that gets amortized over the remaining life of the debt to which those swaps were assigned.

So, um, we are reducing the interest rate gap a bit, and beginning to get positioned for what should be a more normalized interest rate in environment over time.

But retaining a bit of a gap.

The overall risk, I think, as a proportion of our total income remains quite low.

On capital, our total stock equity and stock preferred has hit $100 billion.

Return on common equity is 19.2, our two-one ratios have strengthened last quarter, down a bit from a year ago, we got the advantage of minority interest on tap.

The deter on ratio is up from 8.7 last quarter to 9 and total capital ratio is up as well, GAAP assets running at a trillion 187.

So another great quarter.

Let me turn it over to questions.

Operator, are there any questions in?

Thank you.

At this time if you would like to ask a question, please press star followed by one on your touch-tone telephone.

You will be announced by name prior to asking the question.

Once again, to ask a question, press star 1 at this time.

The first question is from Henry McVey.

Sir, you may ask your question and please state your company name.

Good morning, can you hear me?

Morning, Henry.

A couple of questions.

One, Todd, can you talk about the card portfolio, you said you sold 1.7 billion of nonstrategic, that was interesting to me, and then the yield on the portfolio actually went up.

Yeah, a couple of things going on there.

First of all, we had a co-branding arrangement on Sony, on a Sony card.

They had a right to move that to somebody else.

They bid that out and actually Bank One won the co-brand, so we, as part of that, normally one sells the co-brand to the new operator of the co-brand instruments we sold that to Bank One.

That was the majority of what happened.

Again, nonstrategic because the relationship with Sony has now moved to Bank One.

The second thing that is going on that caused the margins to improve a little bit is during the quarter we cut back a bit our marketing for teaser rates.

We felt things had gone a little bit too far.

We didn't see the kinds of returns we would like to see in some of the teaser rates as the offers got a little bit too aggressive.

We cut that back as a result of the Balcon that’s a percentage of our total that came down a bit.

Okay.

Just a couple other, on the international side, if you look at Europe on the corporate, revenues were up 11%.

Earnings up 53%, and then if you can just give us more color and second, the Latin American repositioning, I guess, I wasn't familiar with you guys were repositioning.

You can break out of that 300 million of whatever you said drag cost.

How much of that was related to Latin America, and is there more to come.

On Europe there was good revenue growth but also improved credit, that's why the earnings grew as much.

Plus there was expense controls there, so expense was, I think, under good control in Europe, and we're continuing to look at ways to reduce that.

So, very strong performance out of Europe.

We've got a nice job with the corporate investment banking franchise out there.

On Latin America, this was part of our ongoing look at which countries to be in and, you know, how to operate in the ones that we are in, and we made decisions during the quarter that we would reduce operations in some of the countries, perhaps, you know, get smaller and a couple of them, and in general, we'll also look at our front-end structure and reduce some of the overlap in sales people that we have covering accounts.

And so, it was a combination of those three things that we looked at, and the result of that was we were able to take some decent costs out of that business and of that, you know, 300 million, we don't -- we don't disclose much, but it was a fairly significant piece of that was the Latin America restructuring piece.

A final question.

On the international consumer finance, the yield on the portfolio went down, from it looked like, 14%, and the first quarter to around 12 and then you had the tax credit in there.

You said that it, you know, should mark the low.

But if you take out the tax credit, you're still running materially below where we were in the first quarter.

So you can just help us understand how we should think about that.

Talking about international consumer finance?

Yeah, Japan in particular, maybe.

Mostly driven by Japan, obviously.

Part what have was going on, the yield goes down because the yield in Japan is higher than what you see in Europe.

As the Europe portfolios grow and the Japan portfolios shrunk, you see that yield come down.

In addition, some of the new products we'll begin putting on have done a little bit of in Japan will be safer but lower rate products that we offer in Japan.

And I think what you're seeing now is, and we continue to provision a little extra on the credit side there, and we had some additional severance costs that we had during the quarter in Japan.

And I think what you're going to see now is a beginning of a firming of the operations.

We're going to go back to, now that we redesigned the products a bit, we feel that we have the collections now under control.

We have the underwriting in a way that we're comfortable that we're going to go back and begin the market again.

So rather than having a portfolio that is declining each month, you're going to start seeing some more, you know, I think an increase, steady and controlled, but some more growth in the portfolio in Japan.

You will see that reflected in the recovery of the income from today's levels.

I think the level today, you know, minus the tax benefit is -- it will be the low you will see for the year.

Thank you.

Thank you, Henry.

Thank you, Glenn Schorr you may ask your question and please state your company name.

Thanks.

UBS WARBURG.

Morning.

Hi, Glenn

Hello there.

To finish off the question on the expense side.

The $130 million increase in noncomp expenses at the investment bank, you -- I guess you spelled out between severance and in Latin America and stock expense.

Could we assume that maybe half of that is nonrecurring in nature?

Is that a fair enough yardstick?

I think that's not far off.

Yes.

Okay.

On the legal side, expenses up in the corridor, and they're different than the reserve.

Can you just give a comment, especially given the recent rulings out of the New York State district court, confidence in legal reserves, and I realize that the the research-related matter, it was probably smallest of the three pieces of the reserve taken in the fourth quarter.

Yeah, I would say we feel confident the reserve is adequate at this point and, you know, hopefully we'll do a good job of fighting against some of these things, and if we do, it should be adequate.

Nothing's changed on that from the previous quarter.

I'm also certain that our legal expenses will remain at relatively high levels.

We are spending a lot of money given all of the issues that we faced versus numerous lawsuits around the place, resulting in just, you know, month-on-month.

We write bigger checks than we would like to law firms, so I think that will continue as well.

Right.

With -- with the Enron bankruptcy plan out, does that mean anything for timing on any of those cases?

In other words, are we still day-to-day on the shareholder and the employee suits?

Yes, we are.

Okay.

And then, don't beat me up too much on this, Todd, because I appreciate the capital management and dividends, but with the increase in the payout ratio.

Right.

Should we be thinking of that as a, maybe an allocation of what gets paid out to shareholders, as opposed to there will be less deals and we have less areas for growth on the outlook?

Yeah, I think that's what I was trying to show on page 3, the dividend increase piece, which is, you know, with this dividend, and you saw the stock repurchase for the quarter come down substantially from the average that we have done in the previous quarters, you know, we were at $360 million for the quarter.

Before that, we were running, you know, a billion to a billion and a half typically per quarter in share repurchases.

We would expect to continue to have, you know, a much lower level of share repurchases, a much higher level of dividend, and the total that goes back to shareholders between those two approaches to be about the same, which leaves the same amount that we would have had historically for organic growth or for acquisition.

Great, well, thanks very much.

Good quarter.

Thanks, Glenn, appreciate it.

Thank you, Richard Strauss, you may ask your question and please state your company name.

Okay, yes.

Deutsche Bank.

Hi, Richard Hey, how are you?

Good, thanks.

Good.

You were first out with a note today.

Congratulations.

Thank you, okay.

Listen.

On the capital return to shareholders, I guess one, I would have thought there would have been an added benefit on top of the $2.3 billion that you have been returning to shareholders on a quarterly basis, and is that still something to think about.

And then -- and then I guess also, with regard to the same thought, I know you have been talking about, you know, retail banking being an area, you know, where you're looking strategically at.

GSB obviously worked out phenomenally well.

You know, is that where you're still focusing your attention, or is it more transaction services?

Where should we be thinking you're focusing your attention on this front.

On the first issue, you know, obviously with the increase in the dividends, that's -- that's not as flexible as share buybacks, but as we look at each other quarter, you know, we typically look at the quarter and decide what we want to do with our capital in that quarter.

Sometimes we want to build a little bit, sometimes we feel it's time to do -- be a little more aggressive on the share repurchase.

I would say on average you should think about returning the same amount to shareholders between the two each quarter, but we'll look at that, and if it makes sense to repurchase more shares, we will.

And, you know, we have increased the dividend for what is it, Sheri, 17 straight years?

Um, and so, again, even with the dividend increase, you know, we certainly would not want to break that streak.

Does that answer your first question?

Yup.

And of the --

On acquisitions, you know, we have got a number of different businesses, you know, all of which we love and retail banking certainly, with the acquisition of EAB and the acquisition of Golden State, we told people we're very clear.

We would like to continue to build that business.

Deals, as know, come up opportunistically.

You have to have the seller and someone to sell for the price we're willing to pay, and so we continue to look at those deals in retail banking.

We also love the transaction services business.

Very excited about having Frank run that business.

I think it's in good hands, and I think that that's also a business that both organically and if, you know, something was to come up from an acquisitions perspective, we would look at it if we could do something where we felt the price was appropriate.

We love the cards businesses.

We have purchased a number of cards portfolios in the past, all which have have turned out quite well for us.

So, that's other business where we, you know, look, we felt we had the right kind of deal, right kind of price.

We look to do deals there.

Asset management and private banking as well, we would love to find a way to buy things there.

Traditionally, we felt they were a bit too expensive, but we'll keep looking.

Uh-huh.

And, you know, on fixed-income trading, I think you mentioned that your positioning in the derivatives was actually a bit of a -- bit of a drag in the sense that as spreads narrow, you know, there was some drag from this.

Do you still have these positions on?

Should we expect that to continue to be the case if spreads narrow that this will, you know, be an offset?

We use that as protection --

Against the loans.

Yeah.

Against our loans.

And so, um, the benefit should be consistent with what I said is happening, with on you how we feel about corporate credit.

The fact that corporate spreads have narrowed.

We would expect the losses faced in the portfolio declined as well.

It should be a decent hedge against losses in the portfolio.

The difficulty is they don't always happen in the same quarter.

The benefit we will see for credit spreads narrowing and presumably losses coming down, the benefit we'll see from that and reduce losses comes in the next two, three quarters.

Right.

But we do continue to have credit derivative on the book.

We use them for those purposes.

We also look at them constantly to get a sense for whether we feel that is appropriate protection we need for certain loans or not.

So we do trade them as well as we get comfortable or uncomfortable that we want that protection.

But, because we have them on and we'll continue to have some on, any narrowing of spreads will certainly result in negative marks and negative revenue for credit derivatives.

Okay.

And widening would be a positive -- credit spreads are darn narrow right now.

Right.

Not sure how much they're going to come in.

Right.

Finally, if you could just comment on fixed-income trends, obviously, you know, we're just a couple of weeks here in July but, I mean, you know, are you seeing anything at this point, you know, that would make us pause in any way?

Relative to the levels you have been posting?

In general, you have -- what happens with fixed income is there was a lot of funding typically in the first and second quarters of each year as most companies go out and they try to get that funding done early in the year so they're not stuck later in the year.

And the first two quarters were, you know, absolute blowouts for fixed income.

So that would imply that you will have a drop-off in the second half of the year in general, in fixed income.

I would be surprised if we didn't have some drop-offs from these levels.

What's mitigating that a bit right now is the fact that credit spreads are as tight as they are, interest rates remain historically quite low.

And so I think a number of companies are continuing to look to issue debt as well.

Great.

Thank you.

Thank you.

Thank you, Michael Mayo, you may ask your question and please state your company name.

Prudential.

Could you elaborate more --

Hey, Mike

Hey, Todd.

Could you elaborate more on your interest rate positioning, from your comment outlier among some large financial firms in terms of benefiting from lower interest rates and what may make you change that, and also the the $1.5 million swap gain, you said that will be amortized over the remaining life.

What is the remaining life?

The, you know, to answer the first question again, we look at the total market and view our interest rate positioning partly as a natural hedge against markets getting worse or credit getting worse, and so, you know, we position for that starting about two years ago and remain comfortable that interest rates were going to be lower for longer than the market had expected.

And so far that's turned out well, for us.

We feel at this stage, given how low interest rates got, that it was time in the middle of the quarter so especially as the rates traded as low as that they did in the middle of the quarter, it was time to take a few chips off the table there.

And, again, you know, remain with some gap as a natural hedge, but a smaller version of it.

In doing so, again, we took off during the quarter, 13 1/2 million of swaps, so I would say the average remaining header in that -- in that book was probably in the, you know, 3- to five-year range.

Okay, one separate question.

Seems like your card balances and accounts are down, even after backing out the Bank One win.

At what point do you say we're going to use teaser rates again to get more aggressive to defend our market share.

Well, I think what we're going to see this quarter, the third quarter, I mean, we're going to have $7 billion of coming on the books from Home Depot, and so we were comfortable not playing the teaser game when it got to be in, our view, was uneconomic, and count on the fact that we're going to have the $7 billion in Home Depot coming on and focus on that for the time being.

When the teaser game gets more realistic, we'll go back into it.

Secondly, there are lots of ways to gain balances other than offering teaser rates, and one of the things that Steve [Friburg] mentioned in the Consumer Day was we're looking at other value propositions out there other than just cost.

Um, you know, so offering special values in terms of airline miles or other benefits like that, doing co-branded deals with those folks.

The economics have turned so those are more interesting ways to put on balances than teaser rates.

Thank you.

Thank you, Mike.

Thank you, Eric Cobell(ph), you may ask your question and please state your company name.

Morning, can you hear me?

Yes.

Blaylock and partners.

Todd, I was wondering if you could offer a bit more color on the consumer credit outlook.

I'm trying to read between the lines from slide 14 on the presentation to some indication of credit, particularly in consumer finance and card, and the data up here is mixed when delinquencies are stable, but the credit loss ratio went up, particularly in Japan.

Is there a sense consumer credit quality is improving or more flat and you're way waiting to get a data for the second half of the year.

You nailed it.

You have delinquencies flat, and so we feel pretty good about that.

Bankruptcies are up, which is why credit losses are up, I'm talking about the U.S. now.

Bankruptcies are up a little bit.

So you've got losses up a bit, but they're up a lot less than they had been in the first quarter or than they had been last year.

That's beginning to stabilize, it looks like, as well.

The delinquencies look flat-ish, they've looked flat for awhile and so that feels pretty good in the U.S.

In Japan, when you have got a -- when you've got balances that are declining in our portfolio in the consumer finance business in Japan, the rate of loss actually goes up, so as you see the turn in the business start growing again, you will see the rate actually come down a bit, and that will be helpful.

There are also a little bit of increase in Bankruptcies in Germany in our consumer finance business in Germany.

Delinquencies remain good out there.

But bankruptcies picked up a bit that.

So that's also increased the credit losses.

I would say on balance that makes it feel, you know, reasonably good that we're going to see pretty stable consumer credit loss rates going forward the next couple quarters.

A quick follow-up, would you say the same of credit losses in capital markets and banking?

Yes.

Okay.

Thanks.

Thank you, Brock Vandervliet you may ask your question and state your company name.

Thanks, Lehman Brothers.

Morning, Todd.

Hi, Brock, how are you?

Good.

Good.

Could you circle back to the Japanese consumer finance business.

I'm still trying to wrestle with what makes you confident to chin up the origination machine again, and I guess another way of asking the question is what was wrong that caused you to pullout to begin with beyond the economy?

Well, I think what we saw happening in Japan going back, I'm now going back about a year ago, we saw a significant amount of increased losses that was driven primarily by Bankruptcies, so things weren't going delinquent, they were going direct from we make a loan to no delinquencies but immediately to bankruptcies.

That got us concerned.

In the third quarter of last year, we tightened up the underwriting.

When you see something like that, you have to be worried about how your front-end machine is working.

We immediately tightened up the underwriting and we also started looking at the expenses.

We collapsed three legal agencies into one as a way of starting to take costs out.

We also invested in the collection machine a little to make sure we were collecting well, and in going through that process, we reduced the marketing, so what you saw was, you know, really trying to reevaluate and reposition the business and try to learn what was going on.

And figure out how to fix it.

So, we did that in the third quarter.

We looked at it in the fourth quarter, we looked at it further in the first quarter, we were able to start testing how our underwriting was going and how the marketing was going.

We started to test new types of products and new types of offers out there.

We started to see the results of the collections that we put in place and the new vintages of loans we were making.

And we also in the beginning of the first quarter of the year changed the leadership out there, and we feel now, having now learned a lot since the third quarter of last year, quarter-on-quarter, that we have a better handle on the types of underwriting we should have.

We should have a better handle on the types of products we should be offering.

We have a good sense of how the collection should work and what is going to be effective there, and that we can, in a judicious and careful way, begin to turn on the marketing machine a little bit more, and have a balance start to grow a bit.

Okay.

Thank you.

Good response.

Thanks.

Thank you, James Mitchell, ask your question and please state your company name.

Hi, Putnam Lovell Securities Inc..

Hi, Jim.

How are you doing, Todd?

Just fine.

A quick question, hate to focus on the expenses too much, just the last two quarters if you looked at --

Nobody's asking me about the dividends.

You're right.

It's pretty straight forward.

You like it?

I do like it.

Good.

Okay.

I was thinking more of a 50% increase, but you beat me to that.

We always like to surprise on the upside.

A good thing.

In terms of the expenses, year-over-year sequentially, the last few quarters, you've had sort of revenue growth and expenses sort of at the same level, not a lot of positive operating leverage.

Obviously you have one-timers in there.

I guess going forward, do you think you have accelerated some in terms because you had better-than-expected revenue performance the first half of the year, I mean how should we look at expenses going forward?

My second question would be on the credit side.

You guys had pretty significant quarter this year so far in terms of the energy business.

That business seems to be improving lately.

I'm wondering why we're seeing higher losses there this year.

That's it.

I think on the merchant energy issue that you mentioned, I think we will continue to see losses in the second half of the year but, you know, versus last year, we had very big telecom and some merchant energy, I think we'll still do better than we did in the, you know, the second half of last year, so I'm -- and, again, the classified loans are coming down, the various classifications are coming down.

So, I'm increasingly comfortable that we, you know, have a full understanding of the issues, that there are not surprises coming in.

Really issues that we have already identified and some of which we have already reserved for that are happening.

Not to say credit losses are going to go away, you know, I think they'll continue; you know, at the levels but better than what we saw last year.

You don't think there is a -- you guys had Enron in the books at a higher level.

There wasn't anything there in terms of catch up on Enron this quarter?

Nothing significant and all of our Enron exposures, is marked to zero.

Okay.

I think on the -- on the expense side, there is a number of things going on in the expense side.

I'm sensitive and nobody's happy about the fact that expense growth is fast as revenue growth.

That is something we focus on a lot, business-by-business in the company.

We have got some things that we thought were the right things to do, one of which was expensing option, that isn't going to cost us more this year.

We said it was going to cost us 3 cents this year, going to cost us more and, you know, than it did last year when it cost us the 0 in the PNL line.

Just what we agreed to do.

We thought it was the right thing to do.

The same thing on the pension side where we thought our expected return on our pension plan from 9 1/2% to 8%. 8% really at the very low end of what you see for major companies out there.

So, you know, we tried to do and consciously tried to do what we thought was the right decision in terms of the pension rate, but that cost us year-on-year in terms of earnings, so those things will continue until we get comparisons that are, if you will, fair, which will be, you know, the first quarter of next year.

At the same time, we have had a combination of spending for investment, so marketing spending is up in some areas.

We have had fairly significant amount of expense getting ready for the Home Depot portfolio to come on our books, but no revenue associated with that.

There was some spending for future growth going on.

There is some expense that's up just because the revenues, you know, when revenues are up 8%, you have to have some expense that is going to be up as a result of that as well.

And then you have got some other ongoing stuff.

The legal expense is something that is just a reality of doing business in the country, so we have that issue as well.

I think that there were -- there have been in the first half of the year, though, pretty significant one-time costs for severance and repositioning of Latin America, which is primarily severance that will start to, you know, disappear and we'll start to see the benefit of that toward the fourth quarter and into next year.

Okay, great, any progress report on the expense side on GSB?

Nothing that we have -- nothing that we're going to talk about yet.

I think we'll talk about that perhaps during the quarter or at the end of next quarter.

The integration has gone spectacular.

Very, very pleased with the performance of that business.

It looks great.

Okay, great.

Good quarter.

Thank you.

Thank you.

Our final question comes from Jonathan Balkind.

Please ask your question question and state your company name.

Fox-Pitt, Kelton, Inc..

Morning.

Morning, John.

In terms of the other income in the global corporate and investment bank popped up this quarter, is there anything unusual there?

Is that equity income coming out of Japan?

What that is, John, a big piece of that is in addition to the realized losses that we have had in the life insurance portfolio for Worldcom, we had some -- some bonds in our corporate investment bank as well and so last year you saw losses flow through into that line from the Worldcom bonds and obviously we don't have that this year.

That was a decent piece of it.

Okay, lastly on the tax rate, it's been trimming it down over the course of the last year.

Can you give us clarity on what you think a good run rate is going forward?

That's a big expense item for taxes, and we have traditionally run at the high level of sort of the international [pier] that you see out there.

We have been running in sort of the 33, 32, 34% range over all, and for a lot of the global players, you will see them run in sort of mid- to high 20s, and about a year and a half, two years ago, we really focused on that, and we began to put in place what is called the APB 23 tax exclusion, which allows to you keep capital overseas and pay tax at a local rate rather than remitting it to the U.S. and pay tax at the U.S. rate.

So, it takes awhile to get those programs in place; and you know, we take a very conservative approach to that, which is we want to make sure we have ways of redeploying that income before we would ever take the benefit on the tax provision line.

So, as that has rolled in, that's been a very big positive to our tax line.

We continue to focus on that as an expense.

I think for the quarter, we're running at about just over 31%.

We were running a little over 31% last quarter, and so we would hope to, you know, not be at the 34% level, but be, you know, more like in the low 30s.

Sounds good.

Thanks, Todd.

Thank you.

Thanks, everyone, for joining us.

If you have further questions, feel free to give us a call.