Northern Trust Corp (NTRSO) 2004 Q2 法說會逐字稿

Please stand by. Good day everyone and welcome to Northern Trust Corporation second quarter 2004 earnings conference call. Today's call is being recorded. Conducting the teleconference today is the Director of Investor Relations, Ms. Beverly Fleming. Please go ahead, ma'am.

Thank you Laurie. Good morning everyone and thank you for joining us to review Northern Trust's 2nd quarter financial results. Joining me this morning are Steve Fradkin, Chief Financial Officer, Harry Short, our Controller, and Mark Beatty, my colleague in Investor Relations.

If you did not receive our earnings release or financial trend report by E-mail this morning, they are both available on our website at www.Northern Trust.com. I also need to mention that this July 21st call is being being webcast live and can also be found on our website. The only authorized rebroadcast of this call is the replay that will be available through July 28. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements such as statement that relate to our financial goals, dividend policy, expansion and business development plans, anticipated expense levels and projected profit improvements, business prospects and positioning with respect to market and pricing trends, strategic initiatives, re-engineering and outsourcing activities, new business results and outlook, changes in securities market prices, credit quality including reserve levels, planned capital expenditure and technology spending, and the effects of any extraordinary events and other matters including developments in litigation and regulation involving Northern Trust and changes in accounting policies, standards and interpretations on our business results.

Actual results, of course, could differ materially from those indicated by these statements. I urge you to read our 2003 annual report and our periodic reports to the SEC for additional information about factors that could affect actual results.

Now let hand the call over the Steve Fradkin.

Thank you Bev. Good morning everyone. Let me extend my welcome to all of you listening to Northern Trust's 2nd quarter earning conference call. We'll be conducting today's conference call in four sections.

First, I'll highlight some of the key financial items in our 2nd quarter results. Second, I'll review our second quarter income statement in some detail, providing you with our perspective on specific performance achieved on each of the major line items. Third, I'll take a few minutes to share observations and offer perspective on some of the developments we are seeing in our businesses.

Finally Bev and I will be pleased to take your questions. Earlier this morning Northern Trust reported record 2nd quarter 2004 earnings per share of 59 cents, up 97% as compared to the 30 cents reported in the second quarter of 2003.

Please recall that our comparative results from a year ago, had a number of special items including employee severance costs of $23 million, occupancy charges of $16 million due to exiting excess space. Software charges, $9.5 million related to the standardization, or elimination of some software. $20 million loss on sale of our former Atlanta based retirement consulting business and $18 million gain on the sale of our Higgins Road retail branch here in Chicago. The combination of these five items reduced second quarter 2003 net income by $32 million or 14 cents per share. Our percentage increase in earnings per share would have been 34% year-over-year if you exclude these unusual items from the comparison point of 2nd quarter 2003 earnings per share.

We are pleased with this 2nd quarter 2004 earnings performance. Let me now highlight for you five key factors that contributed to our results.

First, from a macro perspective and notwithstanding the continued low absolute level of interest rates, the external environment showed marked improvement versus last year. Standard & Poor's 500, NASDAQ, and EBA Industries were up 17%, 26% and 30% respectively, as compared to June 30 2003. Market performance in 2nd quarter of 2004 was more subdued with most indices flat or up only slightly. All market indices remain well off their all time highs achieved in March of 2000.

Second, trust fees in our corporate and institutional services business unit equaled a record $176.2 million in the 2nd quarter. This record performance in C&IS was driven primarily by higher global custody fees and strong performance in securities lending during the traditional annual seasonal peak driven by the international dividend season.

Third we achieved record foreign exchange trading profits of $47.5 million in the second quarter. Heightened levels of currency volatility and client volumes fueled our record quarterly results in foreign exchange.

The fourth factor having a key influence on our second quarter results was credit quality which remained very strong. Nonperforming assets equaled $68 million down from $72 million last quarter and $108 million one year-ago. We reported no loan loss provisions in 2nd quarter and experienced only $100,000 in net charge-offs.

Lastly, I want to highlight that our effective tax rate in the second quarter declined to 32.7% from 33.9% in the prior quarter. During the second quarter we successfully settled several state income tax matters. As a result income tax benefits of $2.2 million were recorded due to the reductions in previously accrued income taxes. Throughout any given year Northern Trust and its affiliates file approximately 60 state income tax returns in 39 states. At any given time we have 3-5 audits under way at various stages in the process. Therefore in the normal course of business we will begin and conclude many audits on filed tax returns. The 2nd quarter was unique only in that a number of multi year state audits were finalized in one quarter instead of being spaced out more evenly throughout the year. Offsetting these positive items, was the continued pressure on net interest income caused by low interest rate environment. Net interest income equaled $146 million in 2nd quarter, down $3.6 million or 2% versus a year-ago and down $5.2 million or 3% sequentially.

Please note that in addition to the continuing challenge of margin compression caused by the low interest rate environment ,net interest income was reduced by a $2.5 million client related multi period adjustment. This reduction pertained to a modification of deposit rates paid to an institutional client. We agreed to compensate the client for a rate differential going back 18 months to the 1st quarter of 2003 with a resulting difference recorded as an interest expense item of $2.5 million. Our net interest margin would have been 3 basis points higher had we we not recorded this adjustment. Now let me take a few minutes to review our key revenue and expense drivers in detail.

Revenues in 2nd quarter were $585 million, up 6% as compared to the year earlier quarter. The two biggest contributors to this strong year-over-year revenue growth were trust fees up 14% and foreign exchange trading profits up 45%. Remember, too, that we recorded $18 million gain on the sale of our Higgins Road retail branch in Chicago one year-ago. Adjusting for last year's $18 million gain total revenues were up 10% year-over-year.

On a sequential basis revenues were up 1% versus the first quarter of 2004, with strength in C&IS trust fees and foreign exchange offset by continued weakness in net interest income. Now let me discuss each of the major revenue items in detail.

Corporate institutional services trust fees of $176 million increased 20% or $20 million from last year's second quarter, and were up 6% or $10 million on a sequential basis. Custody fees and securities lending were the key contributors to this strong growth. Custody fees increased $15 million or 28% year over year, to $69 million and $4 million or 6% sequentially. Custody fee growth emanated from particular strength in our global custody business.

Global custody assets at June 30 equaled $828.5 billion, an increase of 41% or $239 billion versus one year-ago and 1% or $5 billion sequentially, Securities lending fees equaled $36 million, up 30% or $8 million versus one year-ago and 29% or $8 million compared to last quarter. Securities lending volumes were very strong with quarter end collateral values equal to a record $160 billion up 38% a year-ago and 2% sequentially. It is worth remembering that the second quarter is typically a seasonal peak in lending given the impact of international dividend season. Investment management fees in C&IS of $56 million were up $4 million or 9% versus a year ago and down 3% or $1.7 million sequentially.

This sequential decline was concentrated in the fees that we earn on our short duration assets, otherwise referred to as cash. During the quarter, average assets in our institutional money market funds and in our cash sweep vehicles, declined by approximately $3 billion. In reviewing this decline we found our clients undertaking very normal redeployments of cash in the ordinary course of business. For example, one fund manager client, for which we provide custody and related services for their commingled investment vehicle, experienced significant contributions during the second quarter from their underlying investors. The fund manager, in turn, utilizes our cash management capabilities as a means of optimizing the returns on this cash while it awaits the period end, when the cash can be invested into their fund. When their fund opens to investors at period end, cash is re-deployed out of our cash fund and reinvested into the underlying commingled vehicle.

Provision of services to fund managers is a direct client base through our global fund services practice is an area of continued success for us. This is a good example of how the services we provide expand beyond core custody. Net new recurring business in C&IS in the second quarter equaled an estimated $13 million in annualized fees. This compared to $16 million last year and $18 million in the first quarter. The $13 million level represents 7% of total C&IS trust trust fees, an indicator of the good organic growth we are achieving in C&IS.

International business continues to be strongest contributor to new business in C&IS. In addition, we continue to see excellent new business flows from existing clients. During the second quarter, 63% of new C&IS trust fees came from existing clients adding more products to their existing Northern Trust relationship. As we said in the past, in both up and down quarters, net new business results from C&IS are uneven from quarter to quarter due to timing of clients decisions, transition planning and other factors. Notwithstanding this variability, we continue to be pleased with C&IS net new business results over the last 18 months.

Assets under administration in C&IS were up 26% from year-ago to $2.1 trillion and essentially flat as compared to last quarter. C&IS managed assets of $422.5 billion were up $93 billion or 28% from last year and up 2% from last quarter. Both custody and managed assets in C&IS were at record levels on June 30.

Our personal financial services business unit reported second quarter trust fees of $160 million and increase of 9% or $13 million compared to the year-ago quarter. PFS trust fees were down 1% or $1.6 million from the first quarter of 2004. The sequential decline in PFS trust fees relates primarily to the end of the tax season and the traditional reduction in tax preparation fees. Illinois fees were up $3 million or 6% year-over-year or down $2 million or 3% sequentially. Florida fees up $2 million or 6% from last year's second quarter and down $500,000 or 1% sequentially. Trust fees in our remaining states increased $6 million or 15% versus last year and $1 million or 2% sequentially. I'd like to now highlight a change we made to our fee calculation methodology this quarter.

Recall that during the first quarter conference call we detailed a change in our fee methodology for some of our PFS states. In the first quarter of 2004 we began calculating and collecting fees on a monthly basis in Illinois, Texas, Arizona and several other newer states. I amendment pleased to report during the Memorial Day holiday weekend this quarter, we converted Florida from legacy trust system to our consolidated systems platform in Chicago.

This conversion, amongst other changes, shifted Florida to a monthly calculation, beginning on June 1st. Our Florida operation had previously calculated fees using an average daily valuation methodology. This change in Florida fee calculation methodology had no impact on 2nd quarter trust fees. Never the less, for those of you who maintain models on Northern Trust this will be a factor for you to note as you develop your future projections. All of our states are now on a consistent monthly fee methodology.

I want to mention another additional point to bear in mind. While the markets as measured by the S&P and NASDAQ were up slightly from the end of March to the end of June, when you use our monthly prior month end methodology, both measures were actually down slightly. This phenomenon is an important one to consider each quarter as it does impact PFS fees.

Trust fees in our wealth management group, which serves families typically with assets of $75 million or more, equaled $19 million up $2 million or 13% versus a year-ago. Wealth management fees were flat sequentially. For those of you with detailed fee models wealth management fees remain on a one quarter lag basis. Recall that the major market indices were either flat or slightly down as of March 31.

Assets under administration in wealth management equaled $94 billion, up $23 billion or 33% from one year ago and $1 billion or 1% from last quarter. Managed assets in wealth management totaled $17.8 billion at June 30, up from $14.5 billion one year-ago and down slightly from $18.2 billion at March 31. PFS new business results in 2nd quarter equaled an estimated $10 million dollars in net new annualized trust fees sold. This compares to an equivalent $10 million level one year ago, and $9 million last quarter.

On a sequential quarter basis we continue to see steady upward trends in PFS net new business results. In the past four quarters we have seen net new business right a steady $1-2 million each quarter. We are encouraged by the sales momentum. Total assets under administration in PFS at June 30, equaled $205.5 billion, up 19% from a year ago, and flat versus March 31. Managed assets in PFS equaled $104.9 billion, up 11% or $11 billion from a year-ago and down 1.5% or $1.6 billion from March 31. Almost 2/3rds of the sequential decline in managed assets relates to the previous mentioned conversion of our operations in Florida from a local vended legacy system to our consolidated systems platform in Chicago.

We now compute managed assets for Florida with greater granularity, given the fact that assets of our Florida clients are now housed on a more functionally robust operating platform.

Specifically, we will now be able to calculate managed assets for our Florida clients at a holdings level instead of an account level. In a new system if there are assets within a managed account for which we do not have investment responsibility, those assets can now be excluded from managed asset total. Examples include legacy share holdings or a family business.

We are quite comfortable that the decline in PFS managed assets is predominantly due to this conversion. The conversion and the change in managed assets calculation had no impact on PFS trust fees. As I mentioned earlier, foreign exchange trading profits reached a record $47.5 million in the quarter, up $15 million year-over-year, and up $6 million sequentially. The year-over-year results were driven by the two traditional drives of foreign exchange results. Market volatility and fund manager transaction volume. To be more specific, volatility was seen in the major currencies, particularly the euro, yen and pound sterling.

With respect to the year-over-year volumes, the improved global economic climate contributed to increased client activity. Securities commissions and trading income equaled $13 million, down 14% year-over-year, and 11% sequentially. Historically retail commissions, including equities, fixed income and mutual funds, represented the bulk of this revenue line item. The equity trading environment weakened progressively during the 2nd quarter and fixed income volumes were particularly weak in anticipation of the tightening move by the federal reserve. Both of these factors contributed to the weakness in our retail trading commissions.

The bright spot however was the transition management services we provide in support of our institutional clients in C&IS. Technician management fees were at record levels during the second quarter and are a growing component of this line item.

Other operating income in the 2nd quarter equaled $19.2 million as compared to $35 million in the same period last year and $19.7 million last quarter. Recall that last year's results including a gain of $18 million on the sale of Higgins Road retail branch in Chicago. The largest components of other operatings income are various banking relating fees such as loan, deposit and letter of credit fees. There were no material changes up or down in this line item during the 2nd quarter. Net interest income equaled $146 million, down 2% or $4 million from a year-ago and 3.5% or $5 million sequentially.

A large contributor to both sequential and year-over-year declines was the $2.5 million client related adjustment to interest expense that I mentioned earlier. In addition, you will note that we continue to see a shift in the mix or composition of our earning assets. You will see that we experienced a year-over-year move toward lower margin money market assets, away from higher yielding loans. The net effect of these events and the continued low interest rate environment put further pressure on our net interest margin which stood at 1.6%, down from 1.76% last year and 1.73% last quarter.

You will also notice growth in our balance sheet which averaged $41 billion in 2nd quarter, up from an average balance sheet of $39 billion last year. The growth in our balance sheet emanates directly from the excellent growth we're seeing in our international business. This is clearly evident in the growth in foreign office time deposits.

Over the the past five years foreign office time deposits have grown by 14.5% on a compound annual growth basis. As our global custody assets have grown, so too has the level of short term deposits that our clients leave with us on our balance sheet.

I hope this helps you to understand the balance sheet growth in recent years.

Loans during the 2nd quarter averaged $17.3 billion, down 1% compared to a year-ago. Loans to individuals were up modestly with residential mortgages up 2% from last year.

Residential mortgages averaged $7.9 billion and represented 46% of our total average loan portfolio. Personal loans were up 1% to $2.5 billion. Commercial loans declined 15% from a year-ago to average $3.4 billion in the quarter. Like some of our peers in the banking industry, we are beginning to see a pick-up in demand for committed credit facilities and borrowings. Competition for new opportunities, however, is intense. We are seeing over subscribed deals that lead to pro rata share reductions for all participants and we continue to be very conservative in our credit approval process.

As I mentioned at the outset of this call, credit quality continues to be very strong. During the quarter, our provision for credit losses was zero, as compared to $7.5 million provision last year and a negative provision of $5 million last quarter.

Nonperforming assets totaled $68 million, down from $108 million one year-ago, and $72 million last quarter. Our ability to take no loan loss provision this quarter is indicative of our excellent credit qualities.

Now let me shift my comments to a detailed review of expenses. Expenses during the 2nd quarter of 2004 equaled $377 million, down 9% or $35 million from the year-ago quarter and flat sequentially. Recall that last years 2nd quarter included special items totaling $48.5 million, which I outlined at the beginning of this call. Excluding last year's special items, expenses would have been up 3.6% year-over-year.

Compensation expense equaled $167 million, down $11 million or 6% year-over-year and up $1.4 million or 1% sequentially. If you exclude the $17.6 million portion of last year's severance charge that was booked in the compensation expense category, compensation expenses would have been up $7 million or 4% year-over-year. This adjusted year-over-year increase reflects higher incentive compensation, due to our improved corporate performance. The sequential increase in compensation expense, reflects annual salary merit increases for our staff which became effective on April 1st.

Head count continues to be aggressively managed and equaled 8,030 full time equivalent positions at June 30, down 26 positions from year-end and 209 from June 30 last year. Full time equivalent staff was up 36 positions sequentially reflecting our overall business growth.

Employee benefit expenses equaled $43 million, up 25% or $9 million versus last year and up 12% or $4.5 million sequentially. If you exclude the $1.9 million portion of last year's severance charge that was booked in the employee benefit expense category. Employee benefit expenses would have been up $10.5 million or 32% year-over-year. This adjusted year-over-year increase in employee benefit expense relates to higher pension expense as described in our 2003 annual report, and higher ESOP and 401 K expenses due to improved corporate performance as compared with last year.

Substantially all of the sequential increase was due to our ESOP plan, which is calculated based on a formula, and was up due to better corporate earnings performance. Occupancy expenses of $31 million were down $14 million,or 31% year-over-year and were essentially flat sequentially. If you exclude the $16.1 million special charge last year, occupancy expenses would have been up $2 million, or 6% year-over-year reflecting higher rental rates.

Equipment expenses of $20 million were down 10% or $2 million year-over-year and up 2% sequentially. Other operating expenses of $116 million were down $17 million, or 13% year-over-year and down $7 million or 5.5% sequentially. If you exclude $12.9 million in special charges taken last year, other operating expenses would have been down $4 million or 3% year-over-year.

Now to understand the sequential decline, recall that last quarter we reported and $11.6 million processing loss in our securities activities. We had no comparable item this quarter.

However, some custodian fees, staff hiring and relocation costs were up in quarter reflecting the growth in our global custody business, and a continued staffing of positions overseas. We repurchased 863,000 shares of Northern Trust common stock in 2nd quarter at a cost of $36 million. Diluted shares averaged 223.3 million versus 224.4 last quarter. We can purchase an additional $8.4 million shares under our buy back authorization.

Finally, in keeping with our practice we increased common equity by 7% versus one year ago to $3.1 billion at June 30. This represents the 65th consecutive quarter we have increased common equity.

Let me now take the final minutes of this call to provide some broader thoughts and perspectives on the quarter and our business. First , a perspective on interest rates and our positioning. I would like to take a few minutes to answer three questions you might have with respect to our net interest income positioning, and to reiterate comments that we have made in the past. Your first question might be, why will a higher level of interest rates benefit Northern Trust in the medium to long term? We commented in the past about the negative impact that the low absolute level of interest rates has on our our net interest income and securities lending activities.

We have also suggested, that with all things being equal, both of these businesses are positioned to benefit from a higher rate environment in the medium to long term. There are two main reasons for this benefit.

First, our private client business generates retail deposits for Northern Trust. At June 30 we had $7.3 billion in savings and money market deposits on our balance sheet. Rates paid on retail deposits typically lag increases in short term market rates. We should benefit from that lag.

Second we had $6 billion in net non interest related funding as of June 30. As rates rise we will be able to reinvest those funds into higher yielding assets.

Second, you might ask what will be the short term impact of the June 30 Fed rate increase? I should remind you of the comments we made at our June 16 Investors conference in New York, we have a conservative liquid short duration balance sheet. Over 80% of our investment portfolio has a weighted average duration of 3 months. In the short term, over the 3 month repricing of this investment portfolio, we are liability sensitive and therefore will see some pressure on our net interest income as rates rise. That pressure is expected to be seen most significantly in this year's 3rd quarter following the June 30 Fed increase of 25 basis points.

Third, you might might ask, what will be the impact on subsequent quarters of future rate increases? Future rate hikes are expected to have a diminished short term impact on Northern Trust. Unless future Fed actions are more aggressive than what is currently expected our margin on short term investments in future quarters should not be negatively impacted by expected rate hikes. I hope this helps you to understand both the short and long term effects of rising rates of Northern Trust. . Next, let me offer an observation on PFS performance. As we have noted in previous calls, investor sentiment continues to be less than robust and the effect is still being felt on our core private client business.

You have seen this in PFS net new business results over the past two years. In the 2nd quarter however, we recorded our best net new business results since the 2nd quarter of last year and began seeing encouraging signs that investor attitude and and decision making is improving.

We like our competitive position in the PFS business, and believe our model featuring integrated local delivery, broad product breadth, and unsurpassed staff expertise positions us well to benefit as the investor sentiment in the affluent sector continues to improve.

Third, let me comment on the excellent momentum in our C&IS business and international global services segments in particular. As we noted in other forums. the international business and relationships with fund managers continue to grow in importance. We like the opportunities we see with institutional investors outside the United States and with global fund managers for institutional asset servicing and fund administration services.

Privatization, globalization, cross border investing and outsourcing are all factors contributing to the overall attractiveness of the market for investors seeking out sophisticated relationship oriented global asset servicing providers. The Northern Trust solution is winning in the market, as best exemplified by the outstanding growth in our global custody assets, up over 30% on compound annual growth basis over the past decade. A time period when the EISA index was unchanged. We now have over $828 billion in global custody assets, representing almost 40% of our total C&IS administered asset base.

Another exciting area within C&IS is our global fund services segment. In this group, we provide a variety of services to a growing list of fund managers, meeting their complex operational needs. Recent wins in this space include an important back office relationship with Julius Bear and a $31 billion win to be the sole global custodian for the U.K. collective investment fund of M&G, Prudential and Scottish Amicable .

Fourth, we remain very excited about several growth areas in our investment business. As you know our path of asset management acquisition positioned us as the third largest index manager worldwide. We have proven the success of this acquisition through the steady flow of new business into our base of index assets. We won $40 billion in new index business in 2003, a significant accomplishment that overlapped with our successful integration of the $75 billion in acquired assets. During first half of 2004 we added another $29 billion in new wins.

In addition to our positioning and excitement around the passive business, we are also experiencing strong growth in our hedge funds and multi manager programs. Our hedge fund product increased to over $900 million at June 30 from $495 million at year-end 2003. Our manager of manager assets almost doubled from $12 billion, 15 months ago to $23 billion at June 30. These are two examples of the continued diversification of investment solutions that are being sought by our clients.

Finally, a reminder about the expensing of stock options. We will continue to account for stock based incentives under accounting principals board opinion #25 and to disclose pro forma impacts under Financial accounting standard #123. Our form 10 Q filing will show that the pro forma impact of expensing stock options was 7 cents per share in the first six months of 2004 versus 14 cents in the first half of 2003. The lower pro forma impact this year, reflects the elimination of our broadbased stock option plan, and the elimination of our cash equivalent bonus options. Our traditional executive stock option program remains in place. We will start expensing stock options when the final guidelines are issued and become effective, at this point in January of 2005.

In summary, our second quarter performance was strong. We exhibited good top line growth combined with excellent expense management discipline. As compared to last year the macro economic environment has improved materially. While many mixed signals exist in the current environment, we continue to like the demographics of our businesses, the improved new business results in our private client business and the exceptional growth in our institutional franchise.

Now, I will be happy to answer any of your questions. Laurie, please open the call for questions.

Thank you Mr. Fradkin. Today's question and answer session will be conducted electronically. If you would like to ask a question today, simply press the star key followed by the digit one on your touch tone telephone. Again, that's star one. Also please make sure to disengage your mute function on the phone to ensure your signal will reach our equipment. We ask that you please limit yourself to one question and one follow up question at this time. We will take our first question from Tom McCandless with Deutsche Banc Securities.

Good morning. The question I have is related to your foreign exchange results which were terrific. I'm wondering if you've had a significant uptake in customer acceptance and usage of your product that compliments movements in the marketplace that occurred during the 2nd quarter? Because I understand the market movements were the same -- sorry were quite active in the quarter and most of your competitors had similar language in their press release, however, I don't think any of them had as good a results as Northern Trust did on a sequential quarter basis. So I'm wondering if there's just some additional reasons perhaps as to why Northern's numbers were the best.

Thanks Tom. I don't think there is anything particular that we can point to. As you can see the year-over-year volume and volatility was up.

Volatility was down slightly sequentially although there was significant volatility vis-a-vis the yen. I can't say that I can point to any specific enhanced acceptance that we could definitively pin down as a trend.

Would it be possible that the strong addition of new international customers during the past years have helped toward the natural organic growth?

Well, I can only say that, as we have emphasized, in the C&IS side of our business when your target international customers who do tend to invest on a cross border basis a little bit more than some of our domestic clients. And when you target global fund managers as a client base, it could be a factor. But I don't have any definitive material that would concretely lead you to any trend there.

Thanks and congratulations on a fine quarter.

Thank you Tom.

We'll now move to Mike Mayo with Prudential.

Hi. Seems like your margin already took a pretty big hit. Now you are saying with higher rates you have more pressure in NII. I guess my question is, what kind of reduction are you thinking about for next quarter in NII? What do you consider a normal margin looks like 1.6% margin is well below your historical average. Thanks.

Thank you Mike. I think from a reduction standpoint we don't give any numbers or projections on that. And from a normal net interest margin. Normal has seemed to drop significantly in recent years.We have historically been up at 2%, but I would be cautious and hesitant in saying when or if that will be the new norm coming out of this environment.

So when all said and done the Fed is done raising rates, what do you consider a normal margin these days if not 2%.

I think I will leave the prediction on the normal rate to you.

Okay, just a little more color on why such a big margin decline this quarter. You made the number anyway, but to understand what is going on.

We did have the $2.5 million one time 18 month reduction and that definitely brought the margin down further than it otherwise would have been. I think it was at 160. It would have been 163. And also we have a bit of a mix shift going on, with lower loans and that too is impacting our margin.

Okay thank you.

Sure.

Brian Bidell with Merrill Lynch has our next question.

Great run through of the fundamentals Steve. Couple of questions on the ESOP cost. Is that a one time item or should we be putting that in the run rate.

Thank you Brian. I think you know the way to think about the ESOP is that as you know our earnings performance in 2003 was weak on account of the special items. And our ESOP therefore only paid out its base contribution during 2003. Our earnings performance is clearly better in 2004 so our pay out formula will be stronger than it was in 2003. I'd suggest to you that the run rate in 2nd quarter is indicative of the run rate we expect for remainder of 2004 assuming that our performance remains strong compared to last year.

Right on a year-over-year basis?

Brian, this is Bev. I also suggest another thought to you. That is take a look at the disclosure in our footnotes in both the annual report of this past year as well as 2002. Because there is disclosure in our annual report with respect to the specific ESOP calculation and all that that might help you out.

Great. Thanks. Just one follow up. The organic growth in PFS that is improving can you just give some color on segmenting that between two areas, the lower, 1-5 million high net worth individual and and the more wealth management platform, I guess starting at 25 million and up.

I think we continued to see that the strength in the wealth management sector, as you look at that year-over-year asset growth, the super wealth, 75 million and above wealth management, seems to be behaving a little bit more like our C&IS institutional clients, whereas the traditional PFS clients are still softer than we have experienced historically. Nevertheless, we have seen consistent increases in that PFS net new business, so we are optimistic about the direction we've gone at least over the last 3 or 4 quarters.

So you're seeing more momentum on the lower end as well right now?

Yes, a little bit.

Will you give the equity / income cash breakdowns of PFS and C&IS AUM. Is that anywhere?

In terms of corporate and institutional business managed assets equities was 39%, fixed income 14, and short duration 47. And in the personal client base the managed asset breakdown was equity 51%, fixed income 36% and short duration 13.

Great. Thanks very much.

Thank you.

Next question comes from Tom Mccrohan with Fulcrum Global Partners.

Hi. Good afternoon thanks for taking my call. I appreciate the very detailed view of the quarter, Steve, that was very helpful. On the personal trust side, can you just give me some sense if you have any metrics on, net new clients, I know you've provided the net new business whole, but are you adding clients in the personal financial side?

We are adding clients but we don't have any metrics that we disclose on number of clients.

Okay. You see somewhat of a flat fee trend on some of the trust fees. If is fair to say the number of clients is growing but you haven't seen pricing power. When will you see when the new clients you're adding benefit trust fee growth.

We have been adding clients I think the thing to remember on the sequential decline on PFS trust fees which was 1% sequential decline Remember that was primarily driven by the tax season where we have a traditional reduction in tax preparation fees from 1st quarter to 2nd quarter. That is the driver there.

Gotcha. Okay. One follow up on the credit side the provision level has ranged from zero this quarter quarter to negative 15 provision in the 4th quarter of last year up to a positive position early last year looks like it flattened out. Where are we headed from here. Are we going to start seeing positive provision expenses going forward or flat growth like we saw this quarter.

I don't think I can forecast where we're going, I would just say that our credit quality over the last three quarter has been particularly strong. But forecasting the future is not a game I want to play, so sorry for that Tom.

Okay thank you.

Thank you.

Your next question is from Brian Harvey with Fox Pitt, Kelton.

Thank you. Just had a few questions. First on the adjustment of net interest income side. Was there any sort of system issue related to that why you sort of had to go back and make an adjustment to client accounts. Just trying to get a background on that.

No, there was no systems issue, there was no operating error, Brian. You might think of it almost along the lines of compensating balances and a way that our compensation was adjusted with this client. There is nothing systemic, there is no trend line there it really was a one off multi period at justment.

Second question is maybe you could frame out for us a little bit more on the net interest income side. In your annual report you indicated in one of your footnotes that 100 basis point gradual rise in interest rates would reduce net income by about $6 million, is that still a good guide to you or is there there another way we should think about it.

That is the guide we have out there. A 200 basis points rise above the forecast would have a a $12.7 million decrease to our estimated pre-tax income. To keep that all in perspective as we disclosed in the annual report, page 55, even in 200 basis points scenario the decrease only represents only 2% of our 2003 net interest income. But I think as of now Brian, that's probably a fair way to look at it.

Is there anything you can do to reduce the liability sensitivity through swaps or anything else.

I don't really have a comment on that at this point.

Okay thank you.

Thanks Brian.

Moving forward, we now hear from Ken Houston with Banc of America Securities.

Thank you. Hi Steve.

Hi Ken.

With your comments about expenses in the quarter, that the April 1 salary increase is now in there,as well as the expectation that the employee benefit increase relative to the ESOP is in there. Can we assume that the growth of expenses might be lower than it was, from first to second, kind of all things equal.

I don't think I could make that statement. I think you have to remember that our performance on a year-over-year basis is strong and our incentive expense and our ESOP expense as an example is influenced by performance relative to our plans.

So to the extent that our performance were to continue to accelerate that would be a factor for us. I don't think you can draw the conclusion that it would not rise.

Okay. But, basically, okay so we have to keep in mind just how the rest of the core business is growing when we think about how the employee benefits line could move going forward.

Correct, that ESOP line is influenced by corporate performance.

All else included there isn't any... , you've shown really tight control. Is there any reason to think that that shouldn't continue going forward.

I don't think I can offer guidance on that. I think we tried to manage our overall expenses thoughtfully. Clearly, compensation expenses are tied to that performance so we have to be mindful of that.

One follow up on the securities lending business you are illustrating the short term drag on NII. Can you walk through on one side,just what that relative influence is then on spec lending in the near term, and secondly with the rise in business volumes that you've seen, how much is that rise of business volumes an offset to the typical seasonality that you see in the 2nd quarter.

I think the rise in business volumes is a function of more clients in the program. Larger assets. Assets have grown overall. So I think, that's if you will, the standard reasons. There is a seasonality to it but it is essentially more clients and a larger base of assets.

In terms of the impact of rising rates on the securities lending account, I would only say it is a comparable effect to our net interest income effect. I wouldn't want to try quantity that for you.

You mean a similar effect in that you might have a short term drag but then as spreads increase you should see the benefit as well.

The 2nd quarter is traditionally a peak in the securities lending business. Despite the fact that we have had good volumes and decent spreads the 2nd quarter is typically a seasonal peak.

Sure. Right. Absolutely, I'm talking more about absent the peak are you saying that the underlying trends are that you have a negative impact in the short term but over the medium to longer term just as you indicated about rising interest rates impacting net interest income is that the same way to think about how securities lending could benefit in medium to longer term.

Yes, that's right, forget about the seasonality and just think about the effect of rising rates. And it would be very comparable, it's very short duration of when cash is reinvested. Basically the same profile. You are correct.

Okay thanks.

Thank you.

James Allman with Seacrest Capital has our next question.

Thank you. Could you just comment on the pipeline for new custody business. It seems that the pipeline certainly got a little bit gummed up with the Spitzer investigation and all the other reforms. Are we are the point now where the pipeline starting to refill and companies or clients are starting to think about outsourcing not just more of their back office, but middle office as well. Thank you.

James, thank you for your question. I think the pipeline in our C&IS business continues to be strong. We're seeing great opportunities in our global fund services practice, as exemplified by the $31 billion from M&G, Scottish Amicable, and Prudential. We're seeing attractive opportunities with US public funds, and we're seeing particular opportunity in the U.K. and Nordic regions. I think in our personal business, the pipeline has been strong but the move to decisions has been a little slower, particularly at the lower end of the client spectrum.

Do you expect that the growth rate is going to accelerate in 2005 from what you see in 2004.

I'd be hesitant to predict that. You just don't know.

Thank you.

Thank you James.

Our final question today comes from Jackie Reeves with Ryan Beck.

Actually my question was answered on the securities lending portfolio. One follow up question with respect to the pipeline for the passive asset margins, coming from that passive asset acquisitions, it seemed like there has been a pretty significant follow through in terms of additional business coming from that.

Could you give any more color beyond obviously what you have already given in terms of future business opportunities with respect to that new position in ranking that you've achieved through that deal.

Thanks Jackie. I think what I would say is if you think about where we are in the passive asset management business, we acquired the 75 billion at the same time we cross sold an additional 40 billion and cross sold another 29 billion in first half of this year. As you can probably surmise, those are big numbers. It suggests that the passive management asset business is really an integrated part of our core offering, and we are getting a lot of leverage out of that with our C&IS institutional clients and our standalone asset management clients. So, difficult to predict where it goes but I'd say it is pretty core to what we are doing. We do see clients thinking about custody and passive decisions collectively and that bodes well for us. But, where it is going to go in the future is always difficult to predict.

Thank you.

Thank you.

And Mr. Fradkin and Miss Fleming I will turn the conference call back to you for any closing or additional comments.

Thank you very much Laurie. We appreciate it and we appreciate everyone joining in in our conference call today. Thank you.

Thank you everyone, that does concludes today's conference. We do thank you for your participation. You may now disconnect your line