Northern Trust Corp (NTRSO) 2006 Q2 法說會逐字稿

Good day, everyone. And welcome to the Northern Trust Corporation second quarter 2006 earnings conference call. Just a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to the director of investor relations, Beverly Fleming. Please go ahead, Beverly.

Thank you, Lori. Good morning and thank you, everyone, for joining us to review Northern Trust's second quarter 2006 financial results. Joining me this morning are Steve Fradkin, our Chief Financial Officer; Aileen Blake, Controller; and [Preesy] Sullivan from our Investor Relations team. Preesy joined Investor Relations in June, assuming the role that Mark Bette had held for several years. We welcome Preesy to the Investor Relations team at Northern Trust, and look forward to introducing her to many of you in the coming months.

For those of you who might not have received our second quarter earnings press release or financial trend report by e-mail this morning, they are both available on our Web site at northerntrust.com. In addition, this July 19th call is being Webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 26th. 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, which are Northern Trust's currently estimates or expectations of current events or future results. Actual results, of course, could differ materially from those indicated by these statements because the realization of those results are subject to many risks and uncertainties. I urge you to read our 2005 financial annual report and our periodic reports to the SEC for detailed information about factors that could affect actual results.

Now let me hand the call over to Steve Fradkin.

Thank you, Bev, and good morning to everyone. Let me extend my welcome to all of you listening to Northern Trust's second quarter 2006 earnings conference call.

Earlier this morning, Northern Trust reported second quarter 2006 earnings of $0.76 per share, up 12% compared to the $0.68 we reported in the second quarter of 2005. This was our sixth consecutive quarter of double digit year-over-year growth in earnings per share. Net income for the quarter equalled a record, $168 million, also up 12% year-over-year. On a sequential quarter basis, earnings per share and net income were both up 3% as compared with our very strong performance in this year's first quarter. We are very pleased with these results for the second quarter. Revenues were at record levels, with strong and broad-based performance results. This quarter represented our fifth consecutive quarter of double digit, year-over-year revenue growth. Trust, investment, and other servicing fees, foreign exchange trading income, and net interest income, which together equal 93% of total revenues, all exhibited strong growth in the second quarter. We also were pleased with our expense management efforts this quarter. On a reported basis, we achieved almost 4 percentage points of positive operating leverage in the quarter. Positive operating leverage was also strong when calculated on a sequential quarter reported results basis. All in all, this was a terrific quarter for Northern Trust.

As with prior calls, we've organized today's remarks to address three basic areas. First, I'll outline a few items that you should consider as you analyze our second quarter results. Second, I'll review our financial performance in some level of detail. And finally, I'll offer a few perspectives on each of our businesses. As always, Bev and I will then be pleased to answer your questions.

As discussed in our earnings press release issued earlier today, our second quarter net income was reduced by $15 million or $0.07 per share as a result of increases made to tax reserves associated with our leveraged lease portfolio. The $15 million figure comprises two separate items. First, as many of you know, the IRS continues to challenge industry tax positions on certain leveraged lease transactions, including those of Northern Trust. We maintain reserves to cover tax liabilities and potential related interest and penalties. Each quarter we evaluate our assessment of the adequacy of those reserves. During the second quarter, our evaluation of recent industry developments led us to increase our reserves related to the leveraged lease transactions by $11 million. We continue to believe that these are valid leases for U.S. tax purposes and that our tax treatment of them was appropriate. We believe we have adequately reserved to cover our tax liabilities, including liabilities related to interest and penalties on these transactions. The Corporation will continue to vigorously defend its position on the tax treatment of these leases.

The second component of the $15 million charge relates to the tax increase prevention and reconciliation act, otherwise known as TIPRA, signed into law by President Bush on May 17. This legislation repeals the exclusion from federal income taxation of certain income associated with leveraged leases -- leveraged leases known as ownership foreign sales corporate transactions, or OFSK transactions. Northern Trust entered into five such transactions in the 1999 to 2000 period. Accounting standards require that the cumulative effect of such a tax law change be recognized in the period in which the change occurs. As a result, we have taken an after-tax charge of $4 million to reflect the cumulative effect adjustment of this legislation. We expect no material impact on our income tax expense associated with these OFSK leases in future periods.

The last special item that impacted this year's second quarter was a pretax charge of $4.8 million, or $0.01 per share after-tax related to our decision to exit some office space prior to the end of its lease term. In sum, the incremental tax expense and real estate charge just discussed together equalled $0.08 per share in the second quarter.

With that backdrop, let me review the quarter's financial performance, beginning with our key revenue drivers. Total revenues equalled a record $792 million in the second quarter, up 15% or $105 million to last year's second quarter. We are very pleased with our top line performance this quarter and are encouraged by the results we are seeing across our businesses. Trust investment and other servicing fees were the biggest contributor to the quarterly growth in revenues, up $51 million or 13% compared to the second quarter of last year. Trust investment and other servicing fees represented 57% of total revenues in the second quarter of 2006. Corporate and institutional services fees of $260 million increased 15% or $33 million year-over-year. Total C&IS fees were up 3% or $7 million on a sequential quarter basis.

C&IS trust investment and other servicing fees incorporate three primary revenue areas -- custody and fund administration, securities lending, and institutional asset management. Let me briefly discuss the performance of each in the second quarter. The custody and fund administration component of C&IS fees increased 16%, or $16 million year-over-year, to $121 million. The primary driver of this strong year-over-year custody and fund administration fee growth was continued excellent new business, particularly on the international front. The equity market environment also contributed to year-over-year growth in C&IS custody fees. Recall that C&IS custody fees are built primarily on a one quarter lag basis. At March 31, the S&P 500 was up 9.7% versus the prior year and the EFA index was up 21.5%. On a sequential quarter basis, custody fees in C&IS decreased 3% or $3 million. Recall that this year's first quarter included a non-recurring accrual adjustment to C&IS custody fees of $4.5 million. Custody fees in the second quarter would have increased $1 million or 1% if you exclude this increase adjustment from first quarter custody fees.

Securities lending fees equalled $61 million, up 30% or $14 million versus one year ago. The year-over-year increase was primarily driven by higher volumes. Securities lending collateral equalled $235 billion at June 30th, up 14.5% or $30 billion versus one year ago. If we look at collateral values on a daily -- daily average basis rather than the June 30th point in time, average collateral volumes were up almost 20% in the second quarter of 2006 as compared with the second quarter of 2005. On a sequential quarter basis, securities lending fees were up 26%, or $13 million compared to the first quarter. On average over the last five years, securities lending fees have increased 31% from the first quarter to the second quarter. So this quarter's 26% sequential increase is in-line with our historical experience. Seasonally strong second quarter performance reflects the traditional peak in securities lending associated with the international dividend season. You will note that securities lending collateral declined $5 billion as of June 30th when compared with the level reported at March 31st. This decline is related to the end of the dividend season, which typically begins in the March/April time frame, levels off, and then experiences the most significant dropoff in demand in June. We reported a similar point in time decline on June 30th, 2005, when securities lending collateral equalled $205 billion, down $4 billion from March 31st of that year. When measured on an average daily basis, securities lending collateral increased 10% sequentially.

Investment management fees in C&IS of $62 million were up 4% or $3 million versus one year ago, and down 2% or $1 million sequentially. The year-over-year growth in C&IS investment fees was driven by stronger year-over-year equity markets and new business in both international cash funds and index management. The sequential decline primarily represents weaker equity markets in this year's second quarter and one client that moved business away from Northern Trust after we chose not to renew a pre-existing credit facility. In C&IS institutional assets under custody equalled a record $2.9 trillion at June 30th, up 18% or $441 billion from a year ago and up 1% or $35 billion versus March 31. The year-over-year growth reflects continued new business success, particularly overseas, and higher equity market valuations. Sequential growth in C&IS custody assets this quarter was driven by new business. The positive impact of currency translations was essentially fully offset by the adverse impact of lower equity market. Global custody assets are an important and growing subcomponent of total C&IS assets under custody. Reflecting our outstanding results overseas, global custody assets increased 33% or $358 billion to reach $1.4 trillion on June 30th. Global custody assets were up 5% or $64 billion sequentially.

C&IS managed assets equalled $517 billion at June 30th, up 8% or $39 billion from last quarter, and down 3% or $14 billion sequentially. Approximately two-thirds of the year-over-year increase in C&IS managed assets was the result of the outstanding growth in our securities lending business, with the remainder emanating from our international and global asset management activities. The sequential decline of $14 billion reflects the end of the securities lending international dividend season and weaker equity markets during the second quarter, which primarily impacted our index management business.

Our personal financial services business unit reported record second quarter fees of $193 million, an increase of 10% or $17.5 million compared with the year-ago quarter. Recall that all PFS states are on a consistent, monthly fee methodology. Using this monthly methodology, the S&P 500 was up 9.8% compared to last year. The asset allocation of PFS-managed assets as of June 30th was approximately 49% equities, 35% fixed income, and 16% cash and other assets. With only about half our clients' assets invested in equity securities, the month lag year-over-year equity market increase was a good backdrop to strong new business results. On a sequential quarter basis, PFS fees were up 2% or $3 million. The primary driver of the sequential growth was net new business as the month lag equity markets provided only a modest amount of support. Total assets under custody in PFS at June 30th equalled $235 billion, up 10% or $21 billion from a year ago and were flat sequentially. Managed assets in PFS equalled $123 billion, up 10% from a year ago and 1% sequentially.

Our wealth management group continues to be a strong contributor to PFS results. This group serves wealthy families with assets of $75 million or more. The average size of our custody relationships with families served by the wealth management group is approximately $350 million, signifying the very high end of the market that we serve. Wealth management fees in the second quarter equalled $28 million, an increase of 11% or $3 million year-over-year and 2% or $500,000 sequentially. Custody assets in wealth management equalled $119 billion at June 30th, up 12% or $13 billion from a year ago and were flat sequentially. Managed assets in wealth management totalled $23.5 billion at June 30th, up 14% year-over-year and up 3% compared to March 31.

Another very strong contributor to the second quarter results was foreign exchange. Foreign exchange income equalled $84 million during the second quarter, up 64% or $33 million versus last year, and up 51%, or $21 million -- $29 million sequentially. This business is driven by client volumes and currency volatility. During the second quarter, the market environment for foreign exchange was extraordinarily favorable, leading to this outstanding growth.

Net interest income has experienced steady growth since the third quarter of 2004 and double digit year-over-year growth since the fourth quarter of 2004. This performance reflects the rising rate environment and a growing balance sheet. Net interest income results in the second quarter continued this trend, equalling a record $199 million, up 11% or $19 million from a year ago and up 4% or $8 million sequentially. The primary driver of the increase in net interest income both year-over-year and sequentially was balance sheet growth. Average earning assets equalled $46 billion in the second quarter, an increase of 11% or almost $5 billion year-over-year. Growth in earning assets was broad-based with securities up 16% to average $11 billion in the quarter; loans up 9% to average $20 billion; and money market assets up 12% to average $14 billion. Residential mortgages increased 4% versus last year to $8.5 billion and represented 42% of our total average loan portfolio in the second quarter.

Commercial loans increased 14% from a year ago to average $4.1 billion. Commercial loan growth was fueled by new business in both our large corporate and middle market groups. Corporate loan growth was driven by new client relationships and by demand for loans to fund capital expansion and acquisition. Growth on the liability side of the balance sheet continued to fuel the increase in earnings assets and was once again driven by foreign office time deposits, which averaged $22 billion in the second quarter, up 20% or almost $4 billion versus last year. Continued growth in foreign office time deposits is directly related to our international and global custody success worldwide. Foreign office time deposits represented 55% of total interest-related funding in the second quarter, up from 52% one year ago and 31% at the end of 2000.

Our net interest margin equalled 1.73% in the quarter, down 1 basis point compared with one year ago and down 6 basis points sequentially. The decline in our net interest margin, both year-over-year and sequentially, was attributable to the same phenomenon that we've discussed with you in recent quarters. The growth in our balance sheet, driven by foreign office time deposits, is being invested on the asset side of the balance sheet in lower margin, money market assets and securities as compared with higher margin loans.

Credit quality at Northern Trust continues to be excellent. Non-performing loans totalled only $30 million at June 30th, unchanged from one year ago. We recorded a loan loss provision of $3 million in the second quarter, compared with no provision taken in the second quarter of 2005 and a provision of $4 million last quarter. The $3 million loan provision primarily reflects loan growth in the portfolio. During the second quarter, we recorded $600,000 in net recoveries, as compared with $800,000 in net charge offs one year ago.

Now let me shift my comments to a review of expenses. Expenses during the second quarter of 2006 equalled $492 million, up 11% from the year-ago quarter and up 4% sequentially. Compensation expense equalled $221 million, up 12% or $24 million year-over-year, and up 2% or $4 million sequentially. The year-over-year increase in compensation expense reflects higher incentive compensation due to improved corporate performance, additional staff to accommodate our continued growth and expansion, the April 2006 annual salary merit increases, and stock option expense of $2.7 million. Stock option expense in the first half of 2006 totalled approximately $13 million. As we have said in the past, we expect full-year stock option expense to equal approximately $18 million, suggesting that the second half of 2006 will see about $5 million in additional stock option expense. Staffing levels equalled approximately 9,300 full-time equivalent positions at June 30th, up 4% from the year earlier period. Employee benefit expenses equalled $56 million in the second quarter, up 14% or $7 million versus last year, and up 1% or $600,000 sequentially. The year-over-year increase of $7 million reflects higher costs associated with our pension and 401K plans, FICA insurance, and health care expense.

Occupancy expense in the second quarter equalled $39 million, up 20% or $6 million year-over-year and up 12% or $4 million sequentially. Both the year-over-year and sequential increases primarily reflect a 4.8 million one-time charge in the second quarter related to the exit of a lease prior to expiration, which I mentioned earlier. Other operating expenses of $156 million were up 10%, or $14 million year-over-year, and 7%, or $10 million sequentially. The $14 million year-over-year growth was driven by increased market value and volume-based expenses, such as global subcustodian, asset management subadvisory, and brokerage clearing fees. In addition, we experienced higher technical and consulting fees and software amortization during the quarter. The $10 million sequential increase was driven by domestic, custody depository, and global subcustody fees, travel, and software amortization.

Let me add one final comment on expenses. Our second quarter results included approximately $2 million in expense associated with the development of our operation center in Bangalore, India. This compares with approximately $1.5 million last quarter and $2 million in the fourth quarter of 2005. Our Bangalore facility will supplement our existing North American and European operation centers in Chicago and London, respectively. At June 30, we employed over 110 staff in India, up from 75 at year end 2005. Our staff, which currently work from interim facilities, are expected to move into our new 43,000-square foot building during the month of August.

Northern Trust repurchased 1.1 million shares of common stock in the second quarter at a cost of $63 million. Diluted shares averaged 221.6 million, essentially unchanged from last quarter. We can purchase an additional $1.4 million shares under our buyback authorization. In keeping with our practice, we increased average common equity by 11% versus one year ago to a record $3.7 billion at June 30th. This represents the 73rd consecutive quarter that Northern Trust has increased average common equity.

Let me wrap up with a few thoughts on the positioning and continued strength of our businesses. In C&IS, second quarter net new business continued its consistently solid quarterly performance. We have been successful both in the U.S. and internationally, winning new business from both regional providers as well as our core group of global competitors. Recent publicized wins include the Public Retirement System of Delaware; the Dutch Collective Pension Fund for small and medium-sized privatized bodies; and a mandate from emerging markets fund manager, Prince Street Capital Management. Cross-selling additional solutions to existing clients was equally strong and continues to represent an important new business revenue stream to C&IS. Additional services sold to existing clients once again represented approximately half of our new business during the second quarter.

Our global fund services group, which includes the fund administration business that we acquired over a year ago from Baring Asset Management is increasingly well-positioned as a leader in the growing global fund manager -- fund manager asset servicing marketplace. We continue to make excellent progress integrating the acquired business into our operations. The migration of clients to our worldwide custody platform is complete. The migration of fund accounting clients is also proceeding and on-plan with 90% of traditional funds having been transitioned to our operating system. This past May, we announced that our Guernsey based fund administration office reached a milestone in assets under administration, 20 billion pounds sterling, up 28% since we acquired the business in March of 2005. This growth was led by the excellent success in the private equity and property administration sectors and is just one example of the strength and growth we are seeing in our global fund manager business.

In PFS, we also experienced solid net new business results in the second quarter. This performance was broadly based across the country and included the wealth management group. Our Northeast region has a particularly strong second quarter. Importantly, success in the Northeast is being achieved at a high end of the affluent market with the average net worth of our growing client base in the Northeast coming in well above the $25 million wealth threshold that we had targeted when we expanded into New York and Connecticut several years ago. Wealth advisory, which represents our blended or open architecture solutions for private clients, also continues to represent an important growth driver for PFS. We continue to win client relationships in this segment where we can leverage the breadth of capabilities we have to bring valuable solutions to the complex and multifaceted needs of our clients in this segment. Our wealth advisory approach continues to leverage the manager selection expertise of our Stanford-based subsidiary, Northern Trust Global Advisers. Lastly on the PFS front, we learned during the second quarter that our publication, Wealth Magazine, received the APEX 2006 Award of Excellence in the custom published magazine category. Launching in the spring of 2005, Wealth Magazine is an important client education and marketing tool that helps us communicate with clients and prospects, as well as demonstrates our intellectual capital and expertise on a wide range of financial topics that are of interest to our target market. We are very proud of this award, which recognized the design, editorial content and overall communication effectiveness. Wealth Magazine is simply one more example of the leadership position we have forged in the high net worth business in the United States.

On the asset management front, our asset management arm, Northern Trust Global Investments, continues to be well-positioned to serve the investment needs of our core private and institutional clients. Our broad product lineup, which covers most asset classes and styles, was supplemented in the second quarter with several new product rollouts. In line with the trend toward open architecture and to meet client demand, we rolled out three new multi-manager equity mutual funds in June. These new funds feature a manager of manager approach in which Northern Trust Global Advisers allocates assets to external subadvisors. The new funds will benefit from NTGA's leadership position in the manager of manager investment program area, signified most recently by having received Global Investor Magazine's award for investment excellence in the multi-manager category in April of this year. We also received the award for investment excellence in U.S. paths of equity, signifying our prominent positioning in the institutional asset investment management business.

In closing, were very pleased with our results in the second quarter. We overcame a number of significant one-time items in the quarter. Even within this context, strong top line revenue growth combined with effective expense management and excellent oversight of our credit exposures resulted in attractive, double digit earnings per share and net income growth. And now Bev and I would be happy to answer your questions. Lori, please open the call for questions.

[OPERATOR INSTRUCTIONS]. Glenn Schorr, UBS. Glen, please check your mute function, go ahead.

Glen?

Mike Mayo, Prudential Equity Group.

Hi.

Hi, Mike.

I guess the first question is non-U.S. growth rates versus U.S. growth rates, what was the revenue growth in the U.S. versus Europe?

Well, as we've talked about in past quarters, Mike, the -- in our C&IS business, the international growth continues to be the driver of that growth. We don't break it out by international versus domestic. I would tell you that this quarter we had attractive growth in the U.S. So it wasn't -- it certainly did not all come from the global piece. But that was certainly more than half of it.

Okay. So international's still growing faster.

That is correct.

And the FSG integration, what percent are you done and how's retention and growth off of that platform?

The FSG integration -- well, the integration of the Barings business -- I'm trying to avoid that FSG term, but just as a calibrator and a reminder of kind of where we've been, we talked about an expectation of 14 to $16 million in integration expense for the full-year. In the first quarter, we had $2.4 million -- sorry, Mike -- and in the second quarter, we had $3.8 million. So we continue to be on pace. From an operational perspective, it continues to go well, and I think we're in good shape and like what we're seeing on that front.

But that should be a little bit higher in the second half, then?

Well, we -- what I would say is we haven't revised that guidance.

Okay.

So, yes, if you were to look at it that way, you would expect more in the second half. The other thing I'd say, Mike, is the cross-selling there continues to be excellent. We've had good traction, the pipelines are strong, and as we talked about when we first made this acquisition, we've got a capability now that we simply didn't have and therefore are able to serve existing clients and new prospects with a more fulsome capability set. So we're pleased with it.

Can you remind us what percent of your C&IS revenues are outside the U.S.? Or update us to the end of the quarter, I guess.

Mike, this is Bev. We only provide that figure in our annual report.

That was --

I believe that in 2005 that figure was about 26% on a revenue basis and 29% on a net income basis. We don't provide a quarterly update for that figure.

And then lastly, I guess -- you said global custody assets are up 5% sequentially, but the custody revenues are only flattish on a core basis.

Yes. I think you have to remember there, Mike, that transitions come in all throughout the quarter, and so the revenues won't necessarily match the asset growth.

So we should --

It just takes a little time to catch up.

All right. So we should see that in the third quarter then?

Sure.

Okay, thank you.

You're welcome.

Nancy Bush, NAB Research.

Good afternoon, guys.

Hi, Nancy.

We got a fairly stern [Calvinous] lecture yesterday from State Street about the evils of the third quarter as far as the drop off in securities, lending revenues, and don't annualize ForEx, et cetera, et cetera. Would you send out a similar caution?

Well, I don't know about stern and Calvinous, but I think it is fair to say that when you look at the environmental context in which we've been operating, we had good market growth, so year-over-year the S&P up 9.7% and the EFA up 21.5% on a quarter lag basis, which is the driver for our C&IS fees. You do have the dividend season which was strong, and we had excellent volatility unlike anything we've ever -- volume and volatility in the FX world. So most certainly there is a dropoff that we would expect. And remember that on average, our securities lend -- if you look at our securities lending fees sequentially from second quarter to third, on average over the last five years they've dropped 29%, and foreign exchange has dropped 21% over the same on-average period. So, yes, there will be a softening, one would expect in the second half.

Could you just also speak to net interest income trends, sort of second to third quarter. Because your issues are bit different than theirs as far as you have a greater percentage of your funding from what we would consider to be quote, core deposits, etc. And your continued ability to lag repricing and those kinds of issues.

I think the, Nancy, the lag phenomenon has really gone away for us and really what we're talking about is the growth in the balance sheet and the growth in our foreign office time deposits. So we continue to try and minimize our interest rate risk. As you know, we're very short with our securities portfolio. But the big phenomenon for us is less the lag and more the growth in our earning assets driven by our foreign office time deposits.

Could you just update us on the securities portfolio, where the duration is right now?

Yes, I think -- if you look at our -- a couple of thoughts here. One, the majority of our securities in the available for sale portfolio are government agencies securities, and that's about 88% of our portfolio, at least as represented in our 10-K. The average maturity of that portfolio at year end was 11 months, which compared with 3 months in our 2004 10-K. And the big change there is that we have invested more in floating rate securities, where the maturity is longer but the pricing period is still quite short and conservative. So if you look at the average maturity on this portfolio, it's 11 months, but remember that you have a repricing factor that is significant there.

Okay, thank you.

You're welcome.

Brian Bedell, Merrill Lynch.

Hi, good afternoon.

Hi, Brian.

Or good morning over there, I guess. Just to talk about the foreign deposits again. As we move into the third quarter on a seasonal basis, typically, of course, volumes are lower. Would you expect lower deposits or a potential outflow of deposits that would go against your very, very, very strong trends of good organic growth in foreign time deposits?

Brian, I think it's -- the answer is I cannot predict it. I simply don't know. What I would say generally is that our growth in foreign office time deposits has directionally been consistent with our aggregation of global custody assets. So that's a phenomenon that we've had -- we've been growing our global custody assets at 30 plus percent on a compound annual growth basis for 15 years plus. So directionally I would expect it to be the same. Of course, there is -- there is going to be noise there as our clients decide to allocate more to equity markets or not in any given quarter. But I can't think of any specific phenomenon that would make me clearly believe there's going to be a change there.

Okay. And can you talk about your pipeline in Europe in terms of custody business, in terms of mandates that you expect to convert over the next two quarters versus ones that you haven't won yet but what you would consider as part of your pipeline?

Sure. I think on the C&IS new business front, we continue to see very solid momentum. We've had a good mix in U.S. and non-U.S. wins, and as I mentioned in the call, excellent and consistent cross-selling. I think the themes that I would offer to -- to try and enrich that texture a bit is that in the C&IS business, we're continuing to see greater complexity as we migrate from what I'll call the traditional custody business to everything else we're doing. And you see that manifested in a variety of ways. The cross-border pooling that we're helping with clients, the back- and middle-office outsourcing that we're doing with clients, the hedge fund and private equity and property administration that we're doing for clients, and just an overall tone of more of a consultive sale because of the complexity that our clients are facing. So the pipeline continues to be strong as always. It will be episodic and lumpy as it comes in, but we like the position that we're seeing.

And should we be considering higher revenue yields on that more complex business composition going forward?

I don't think I'd make any projection one way or the other. I think the business continues to be strong, but it's -- there's a lot of mix in there. So I don't think I'd make any forecast one way or the other.

Okay. And then just lastly, can you just remind us of your interest in moving more into continental Europe, particularly Germany, the potential acquisition of a depot bank?

Sure. Well, our international business in C&IS has grown tremendously and consistently for many years. In Europe, it's grown particularly strongly. You'll note that we opened an office in Amsterdam, last quarter, I guess was the official opening. And we have many clients in Holland, in the Nordic region than across continental Europe. We do not currently have a depot bank in Germany, which is a requirement for having domestic German clients, and that's something that we've said we're interested in. But we've got a lot of growth going on. We've also said that we wanted to get the FSG acquisition bedded down. We want to finish the migration of the Insight back-office outsourcing transaction. So it's on our list, but it's not anything that is -- that needs to be addressed imminently. We're growing quite nicely in Europe today.

Right. Great. Thank you very much.

Sure, Brian.

Tom McCrohan, Janney Montgomery Scott.

Hi. Thanks for taking my call.

Sure, Tom.

I had a question about -- I was just trying to understand more when you decide the margin to invest in government securities versus money markets assets. It seems like this quarter you could have avoided or -- not say avoided. You could have probably maintained your [net interest as] margin if you had taken the incremental, whatever, $2 billion of foreign time deposits and invested that in government and other taxable, of which the average yield on those were up sequentially, like, I don't know, 43 basis points. So because you invested in money market assets, obviously, they weren't up. The yield on those wasn't up as much sequentially. So other quarters you've seen kind of the opposite, where you've taken incremental foreign time deposits and put it in money -- put it in government securities, not money market assets. So can you just kind of help us understand how you kind of make that decision and why it was made this quarter to go into government securities -- or not go.

Tom, I think from our perspective the money market versus securities decision is a blended one. I mean, we see them as very interchangeable relative to our risk profile and what we try to do. So they do move around. There's nothing -- I suppose you can always second guess it with a rearview mirror, but there's nothing special that I can think of that happened there. This is -- these are the normal shifts that we make and judgments that we make that occur throughout the quarter. So here's nothing special I can think of there.

Assuming the yields stay the same this quarter, is it fair to say you'll ship those money market assets into higher yielding securities this upcoming quarter?

Well, I wouldn't may any projection about what we'll do there. I'd say we're always trying to optimize those assets with the commensurate level of risk that we're comfortable with. And I think that's as far as I'd go.

Okay. Can you -- separately, can you talk a little bit about the forthcoming television advertising campaign that we've read about you'll begin, I think in 2007?

Yes. We continue to like the traction that we're seeing in our PFS business overall. And as you know, if you look at it on a sort of a long continuum, we've really become a much more national player, particularly over the last several years. And we have indicated that we do plan to do some television advertising as a sort of complement to our national plan, and we're excited about that. But at this point I don't think there's much more to say. Although I know you can sit at the front of your seat and be excited as they come out. And we're kind of excited about it.

Will that be global or just U.S.?

That will be, I think, just in the U.S.

Okay. And is it going to be touting just private client services or any particular segment on the high net worth side?

It'll be focused, I think, on the high net worth side.

Okay. And just one last question, Steve. On your comments in the beginning, I think I heard you say there was a -- there was a situation where you elected not to renew a credit facility with one particular institutional client and as a result lost some business. Was -- is there anything different in your philosophy in how you are evaluating relationships with your customers and the extension of credit? Was this kind of a one-off situation, or is there anything in addition that you can share with us on this situation?

Well, this is one-off in that it was a little bit larger. But, no. There's been no change to our credit process. This is a situation where the client had been a long standing credit. But, of course, their environment changes. And as we've always talked to you and others, we use credit judiciously and we just -- notwithstanding a big and important fee relationship, we didn't feel we could renew it given the changes that we saw on their front. So I don't think there's a change in our standards, it's just one of those situations that is unfortunate. But we knew that would happen if we didn't renew, but we made that choice anyway.

And are you -- are you finding outside the United States that your clients looking for you to extend credit more, and in particular with the new Barings acquisition, is there a credit component with that where you think that your loan books could be growing because you're getting increased requests for credit facilities outside the U.S.?

I'd answer that a slightly different way by saying we do see demand from our fund manager clients, particularly for liquidity facilities. Whether it's from the so-called FSG clients or others. And so we do expect some demand there. But I wouldn't want you to confuse that with sort of traditional, non-U.S. corporate credit demand, which we have not been in the business of providing.

Right. These are just like redemption facilities. That type of thing.

Right.

Great. Okay, thank you. Great quarter.

You're welcome. Thanks.

Robert Lee, KBW Investment Bank.

Thanks. Good afternoon, everybody.

Hi, Rob.

Just one quick question on the C&IS asset growth, assets under management. I mean, if I -- if I strip out the securities lending collateral that's under management, you're up about -- I think it's about 3% year-over-year considering how strong the markets have been the past year and understanding that there's a skewing towards fixed income and cash management there. Could you talk a little bit about what may be holding back asset growth there and what maybe some of the current plans are to try to accelerate that?

I think, Rob, you're right in that it's an important juxtaposition you have to consider when you look at our business is that we have sort of a different mix from many of the other firms you'd look at with sort of order of magnitude -- I don't have the numbers directly in front of me, but 40% cash, 40% index, and largely domestic index both equity and fixed, and then 20% other. So we don't get the same benefit that others get, particularly on the international side. If you look at the EFA index and on the quarter lag basis, it's up 21%. We are a very small manager of international assets. So I think the -- I think it is a mix issue with what we have. Now, we are becoming more global, clearly. But it takes time to overcome the asset base that we have domestically. So I think that's the driver of it for us.

But there's nothing that you think you need to do in terms of a new product set or maybe revamping maybe on the equity side, and invest in process or something.

Oh, I didn't say that. There are lots of things that we need to do and continue to work on. We're doing a lot of work on the enhanced side of our quantitative business. We're doing a lot of work in trying to strengthen our international distribution. We're doing a lot of work and just had an announcement on our liability-driven investing. We're done some interesting work in road shows on private equity and hedge funds. So, no. There's plenty of work to be done. My only point was that when you look at the mix that we have and the historic base of business that we have that we're not going to get the same lift as some others would get.

Okay, thank you.

You're welcome.

Jed Gore, Sunova Capital.

Hi. Most of my questions have been answered, but thank you for taking my question. I just -- I guess I could follow-up with a question on the C&IS business. You had your assets under custody up 18% year-on-year, and your fees were up 16. I would assume that the business internationally has better margins than what you have here domestically. Is that a fair statement? And if you're growing business internationally at 33%, is it in effect what's happening that you're offsetting compression in pricing domestically with international pricing?

Well, I think you've got to remember that the -- the correlation of asset growth to fee growth is always going to be a little off because the timing of when those assets come on. I think secondly, you have to think about the total mix of revenues as opposed to just fee revenues because we think the way we manage the business is on sort of a bundled total relationship basis. So you may get less fee per dollar of assets, but be benefiting with foreign exchange or other dimensions to our income. So it's -- I understand the line of thinking that you're taking, but the way we manage the business doesn't make that an easy one-for-one comparison.

I guess I'm just trying to get a sense then on a relationship basis, how is pricing?

C&IS in our institutional business, the pricing continues to be competitive. I don't think it's degrading significantly. It's degraded so significantly over the last 15 years that on a fee basis, it's hard to see it go much lower. So I think it's competitive.

Okay, thank you for taking my question.

You're welcome.

Gerard Cassidy, RBC Capital Markets.

Good morning, guys.

Hi, Gerard.

I had to jump off the call so I don't know if you touched on this, so I apologize, but on the net interest margin for the quarter, did you guys give any guidance or suggestions on where you see it in the second half of the year versus the second quarter quarter here?

We don't really give any guidance, Gerard. I think we -- as you know, we had the historical -- in the late 90s, early 2000 period, 2% net interest margin. And then we -- as markets dropped and interest rates and so forth, we dropped substantially from that. We've definitely -- we've ranged from 173 to 181 over the last six quarters and I think that's -- what we've said is that's been our more -- what we believe is a more normalized place to be given the mix shift on our balance sheet. But in terms of guidance beyond that, we really haven't offered anything.

Just a technical question. On the taxed -- the $4 million after tax charge for the change in the law, is that in the actual taxes or is that in other expenses?

It's in the taxes.

Okay. And then finally, coming back to the C&IS, the assets under management, is it just a mix -- what caused the decline? Was there something in the mix, whether it was fixed income or something that caused the sequential decline in assets under management in that business?

The sequential decline was the -- Bev, help me. That was --

The majority -- well, securities lending was certainly part of that. The other piece would be our quantitative business -- the equity assets in our quantitative business which were clearly impacted by the markets.

And again, that's -- our quantitative business is dominated by U.S. equity indices.

Okay. So the 517 versus the 531 sequentially was due to the equity index business, and I'm sorry, did you say the securities lending business?

Correct.

Thank you.

Mr. Cassidy, anything further sir?

No, thank you.

Ken Usdin, Banc of America Securities.

Thanks. Hi, guys. Two questions. First, at the May analyst investor day, you'd taken down your ROE long term guidance to 16 to 18, and if back out the tax charges and the one-time item, your operating right now closer to 20. So just wondering if you can give us some context as far as how you're thinking about your returns relative to those long-term. Does this imply that the Company's just running on all eight cylinders right now, or will you ever come up with any type of different thought process on the amount of capital relative to that new target you'd put out.

Well, Ken, now you know why we don't give guidance. I think, look, this was a very strong quarter and recall that our strategic financial targets are on average across time, over cycles through good times and bad times. And remember we did say that we expect that in positive operating environments, we should beat those targets and indeed that's what we're doing in this case. So I would be weary of drawing too long a distinction by what happens in any given quarter. And if you harken back to Nancy's comments on Calvinistic views of the second half, this clearly was a good quarter and we're excited about it, but it's one quarter in a long game.

Okay. And my other question is related to expenses and operating leverage. This is your second quarter of 4 or 500 basis points of -- 3 to 500 basis points, let's say, of a positive operating leverage. And, again, to your point you just made about the strong revenue environment. My question is about, how quick is your ability to accelerate project spending? When you see the better revenues than you had expected coming through? I mean, so do you have flexibility as far as getting ahead of some things or reinvesting, and where do you stand as far as taking advantage of those opportunities in a more near-term sense when you get the sense that the top line is looking better?

It's moderate. Look, a lot of our initiatives are long, multi-year systems projects and so forth. So certainly we try and avail ourselves of that when we can, but you can't rejigger an entire systems docket or investment docket within a quarter. So when there's a chance to do that, obviously, we try and do that. But I would say that it's a big company, it's a global company, it's got thousands of people, and lots of projects and we're not able to jerk it that fast.

Well, so not in a quarter, necessarily, but I mean does it -- do you reevaluate that on a rolling basis? Meaning, like, so if you thought your first half was extremely strong, would you be able to make things happen as quickly as in a couple of months or a couple of quarters? Just trying to get an understanding of how that thought process rolls along.

Yes. We do evaluate how we're performing and what we think is going to happen and what opportunities we have to either accelerate or defer various things. So that is definitely a part of the management process.

Okay, thanks a lot.

You're welcome, Ken.

Mr. Fradkin, there are no further questions at this time. I would like to turn the call back over to you, sir.

Okay, Lori, thank you, and thank you, everyone, for joining us. We'll look forward to updating you on our third quarter results in October. Thank you.

And that does conclude today's conference. I'd like to thank everyone for joining us. Have a good day.