道富銀行 (STT) 2002 Q2 法說會逐字稿

Please stand by. Good day,

everyone. Welcome to the Investors Financial

Services Corporation second quarter earnings

release conference call. Today's call is being

recorded. At this time for opening remarks and

introductions, I'd like to turn the call over to

Mr. Joe DeChristofero (phonetic).

Thank you, operator.

Thanks for joining us on today's call. We'll be

making a number of forward-looking statements

which are based on management's assumptions as of

today. The company's actual results may differ

materially from our current predictions due to any

one of a number of factors. Information regarding

the factors that may affect our actual results is

set forth in the MBNA section of the most recent

10-Q and 10-K. I recommend that anyone listening

to this call review those reports carefully.

Because this call will be archived on our website,

I want to emphasize again for anyone listening at

a later date that the statements made today are

based on our assumptions today, July 11th, 2002.

These assumptions may change, but the recording of

this call will not be updated. Joining us on

today's call are Kevin Sheehan, Chairman and Chief

Executive Officer, Mike Rogers, President, and

John Spinney, Chief Financial Officer. I'll now

turn the call over to Kevin Sheehan.

Good morning. I'll begin by

reviewing some key points from the second quarter

and then John Spinney will discuss our financial

results in more detail and update our guidance on

our models. The diluted EPS for the second

quarter came in at 26 cents up two cents or eight

fence link quarter and up eight cents 44 quarter

two of last year.

As of June 30th we processed approximately

$835 billion of assets for our clients, up

approximately $4 billion from March 31st, 2002,

and $21 billion from the year ended 2001. During

the quarter the S and P 500 index declined

approximately 14 percent and NASDAQ declined

approximately 21 percent. We converted

approximately $19 billion in assets from new

clients during the quarter and added an additional

$11 billion in assets from existing clients.

Finally, market depreciation and client fund flows

reported from a $26 billion decrease in our assets

processed during the quarter. During the quarter

we converted new business we announced on last

quarter's call. This new business included Oak

Mark Funds, CDC Invest Funds, Agone TransAmerica

Funds, and BGI Global ETF Product, MFCI I-shares

(phonetic).

In addition, we expanded our relationship with BGI

by winning the processing mandate for I-shares.

Some of which are expected to commence trading in

July. The pipeline for new business remains at

$40 million in annualized revenue. We define

pipeline as the actualized revenue on outstanding

bids where we believe we have a 50 percent greater

likelihood or greater of winning the new business.

The BGI conversion is on track for completion by

October 31st, 2002, and the second quarter 2002

represents another solid top line and bottom line

performance for our company in a difficult market

environment. These results have been driven by

our ability to sell new business in a declining

market and a continued favorable interest rate

environment. Now I'd like to turn the call over

to John Spinney, who will review the quarter's

results in more detail.

Good morning. As Kevin

mentioned, second quarter diluted EPS came in at

26 cents a share and 8 percent linked quarter

increase. Our diluted EPS of 26 cents represents

a 44 increase over the second quarter of 2001 EPS

of 18 cents. Diluted EPS in net income for 2002

both exclude the amortization of good will in the

accordance with provisions HASBY-142 (phonetic).

Revenue growth remains a key driver of the

company's EPS growth. That off burning revenue

which is made up of net interest income and fee

income increased 4 percent link quarter and

22 percent over the same quarter of last year.

The two components of our revenue, net income are

reported separately financial statement for

presentation purposes, but these two revenue

sources are derived from the same core securities

processing business as clients use the company's

balance sheet as a convenient way to invest their

excess cash, thus generating net income for us.

I'll now walk through the significant income and

expense components in more detail. Debt income

decreased 4 percent link quarter primarily due to

three factors. Interest rate resets on our

variable rate investments, 2Q having 91 days

versus 89 in Q1 in an asset liability strategy to

prepay high rate FHLB advance and replace it with

one at a lower rate.

Despite these factors we maintained healthy net

interest margin and spread percentages as the

yield curve remained steep during the second

quarter. The link quarter interest rates spread

contracted by 33 basis points to 2.26 percent

while net interest margin contracted by 35 basis

points to 2.45 percent. Compared to the same

quarter of last year, net interest income was up

28 percent both due to a steep EPO (phonetic) curb

and the increase side of our balance sheet.

Fee income increased 8 percent link quarter due

primarily to additional client fund flows in

higher income from our securities lending and

foreign exchange services. On a year over year

basis fee income increased 20 percent due to

higher asset levels in 2002 versus 2001 and higher

ancillary revenues in 2002 versus 2001 all

achieved during challenging equity marketing

conditions.

Operating expenses increased 3 percent link

quarter an increase in transaction processing fees

accounted for the majority of the increase in

operating expenses. Transaction processing fees

were up link quarter as a result of higher

transaction volumes in Q2 versus Q1. Comp and

benefits, our largest operating expense, declined

on a link quarter basis by approximately

$1 million. The decrease in compensation and

benefits link quarter as a result of lower bonus

and payroll tax accruals in Q2 versus Q1. Both of

which were partially offset by additional head

count added in Q2 to service new business. We

continue to maintain strict cost controls

especially in the face of weaker equity markets.

I'd also like to address an issue that some of you

may have seen in last month's American Banker,

that we will disclose in our second quarter Q.

Like many other financial institutions in

Massachusetts, we recently received from the Mass

DOR, Department of Revenue, a notice of intent to

asset state excise taxes for tax years 1999 and

2000, 6.2 million including interest. The notice

claims that the bank was not eligible to receive a

95 percent dividends received deduction on

dividends it received from Investors Funding

Corps, the bank's majority owned REET (phonetic.

After consultation with our tax accountants and

legal counsel, we believe strongly in a technical

merits of our case and at this time feel

comfortable with our 1999 and 2000 tax provisions.

As always, we are reviewing a number of business

strategies that may also minimize our tax

exposure. Prospectively we remain comfortable

with our current effective tax rate.

In addition, I received several inquiries

regarding our option dilution disclosure in our

annual report. After reviewing financial

accounting standards 123 and consulting with our

independent accountants, it was fair to say we

have been extremely conservative in our

disclosure. The key drivers of the dilution

calculation are the expected life of the option,

the volatility of the underlying stock, and the

effective tax rate used in the pro forma

calculation. Our 2001 FAS-123 option dilution

disclosure was based upon an expected option life

of ten years, a volatility percentage of 57

percent, and a 30 percent effective tax rate.

Under these variables the resulting dilution as

disclosed in the annual report was 37 percent.

Utilizing the annual expected life of 40 years

volatility over these years of 55.3 percent, an

effective tax rate of 27.3, reflecting the tax

benefit of the compensation deduction, the actual

dilution would have been 18 percent.

I hope this clarifies our disclosure. We plan to

update our FAS-123 disclosure for 2001 in our 2002

annual report. Given our continued strong top and

bottom performance during the second quarter the

continued favorable interest rates environment and

client wins and conversions, we are raising our

2002 EPS guidance to 101 to 103, from a dollar to

102. We remain comfortable with our long term

growth rate of 25 percent in EPS. I'd now like to

open up the call to your questions.

Thank you. The

question-and-answer session will be conducted

electronically. Any participant wishing to ask a

question, please press star one on your touch tone

telephone. We'll take your calls in the order

that you signal and as many as time permits.

Again, that is star one to ask a question.

We'll first hear from Jon Afrstrom of RBC Capital

Markets.

Good morning guys. Pretty good

quarter. Can you give us an update on how much of

the new business from last quarter is already on

the books and how much is left to go on Q3?

Pretty much all the business

we announced last quarter we talked about in this

call has been converted in this call. The last

piece converted on July 1, Jon, so that will be in

place for the full Q3.

And then can you talk a little bit

about value added, what drove some of the results

there.

I think on the value added

side, security funding, we were in a traditional

foreign dividend season, we got a little bit of

benefit from that. We also on the effect side had

good transaction volume and substantive favorable

spread over the period.

And then on the new guidance are

you still saying the 25 percent long term growth

rate should be listed in '03?

Yes.

Thank you.

Moving on, we'll next hear from

Joel Gomberg of William Blair.

Perhaps expand a little bit more

about the exchange rated fund business, how that

has added to business this year compared to last.

How you might make money in that business a little

differently, some of your core business, and then

talk about the opportunity there in the fixed

income ETF business of BGI is rolling out, and

what type of market you think is out there for

those markets. Thanks.

Sure. The ETF business for

us in terms of what it's meant has grown

significantly since December of last year. I

think we started the year at probably 19 billion,

we ended this quarter in 27 billion of assets in

that product. We pretty much own the market in

terms of number of funds out there. I think we

have 75 percent of the funds in the marketplace

and we probably have close to 30 or 40 percent of

the assets in ETF. So the marketplace, we're a

marketplace leader, I would say, Joel.

In terms of how that translates into our results,

as the assets have grown over the first two

quarters, we picked up our traditional asset based

and transaction fee revenue, the other incremental

revenue derive from the ETF, what's called

accretion and redemption fees, and every time an

authorized placement agent wants to create or

redeem one of these units which is denominated, I

believe, 50,000 shares, they give deliver us a

basket of securities plus some balancing cash. We

deliver back the 50,000 units or they can collect

50,000 units in the marketplace deliver back to us

and we deliver securities and cash back to us and

that creates a little more revenue on those

products. It's part of the fixed income ETFs. So

those are - just were approved by the FCC.

Our client enrollment was up in July. We believe

there's an appetite for that market and they've

been very successful in selling the car (phonetic)

product that's growing extremely well and we think

over time that's going to be accepted just as well

as the equity ETFs.

Do you receive the same type of

profitability or fees from the fixed income versus

the equity ETF?

Joel, this is Mike. Really it

works the same way where two pieces of income are

involved, an asset based fee with a minimum

setting out so the asset is raised to a certain

point and then a transaction fee component as John

said those of those transactions are accrual, one,

and redeeming in kind to the portfolio.

Okay. Last question, John, the

balance sheet grew by a billion dollars, period to

period end. Could you explain that?

Sure, period to period end

would happen at the end of this quarter. Well,

first of all, our strategy in terms of our asset

liability management was to (inaudible) the

balance sheet at the at the end of this quarter we

ended up with some late wires from clients where

we had already gone and sold fed funds earlier in

the day and now we were - we bought fed funds

earlier in the day and then the $600 million of

wires came in late in the day and we had to go out

and sell fed funds. So you'll see we had a little

inflation just for that one day for that

$600 million that came in late day that we had to

put out.

Unwind?

Next day.

Thanks a lot.

Yes.

We'll next hear from James Allen

of JLS.

Yes. Great quarter. Could you

give me some comments in terms of what is the

potential that you could sign another big deal

that's kind of a transformation deal such as the

one you signed in California and are you prepared

to do that now and what's the potential we might

see that by the end of the year.

We don't have anything to

announce now. We certainly have the capability.

When we nail one down, that's typically when we

announce it.

Okay. Can you give us a little

bit of guidance on when to think about when we

might be seeing something of that size?

No, I think it's really

difficult to do that. We're certainly competing

for outsourcing business, but I don't think we're

at a stage where we could give you any more than

that for guidance.

Are there significant details that

have a piece out right now?

We're probably bidding on

seven or eight deals that are outsourcing deals.

That are all of that significant

size to your company?

There's nothing that's

$500 billion out.

So just give us an idea, are these

more like $100 billion or smaller, the deals

you're bidding for.

They could range anywhere

from $25 billion to $300 billion.

But a $300 billion deal, that's

pretty significant to your company at this point.

That's right.

That's very much.

Next we'll hear from Timothy

Willi of A.G. Edwards.

Sure. John, if I could ask

another question about the balance sheet. On an

average basis you had nice link quarter growth,

obviously the margins came down but you still had

good interest income. If you could just give us

some thoughts on - I know it's hard from quarter

to quarter, given what your clients may or may not

do but should we expect to see, you know,

continued margin compression but very strong sort

of sequential growth and average earning assets

and are you giving any kind of thought there and

also be sort of curious about you all articulated

125 basis point rate hike assumption, I believe,

when you were giving guidance in the beginning of

the year and you still see that happening or is

that sort of changed as you sort of ponder what

could happen through the next two quarters?

I would say, Tim, good

morning, by the way, the projections we've talked

about in the past I think we've now revised what

we think our outlook is on interest rates a little

bit and we don't think there's going to be much

movement until the end of this year and then we've

got our assumption is probably 100 basis points

over the next 12 months after that is in our

assumption. So if you look at our net interest

margin and spread now I think you're going to

continue to see some compression as the reset

happen in the portfolio as we get paydowns within

the portfolio and reinvest those at lower rates

we're naturally going to gravitate downward, so I

would expect some contraction throughout the rest

of the year.

And then the other question was

some of the value added services. I don't

understand the seasonality in securities lending

which you talked about, but could you talk about

the actual sort of growth of customers or the

portions of customer business that you've been

able to gain, year over year sequentially just the

seasonality or the market volatility. We now have

20 percent of customers giving us 20 percent more

business. Any way you can quantify that?

Off the top of my head, all I

can say to you is all the new business that we bid

or win, as we win business, if it comes with all

the ancillaries, we add them. If we don't get all

the ancillaries, out of the box, we continuously

working with clients the customers to get them

converted on FX and securities lending. I would

say that we have more opportunity now in our

customer base given the fact that we've added more

clients to grow those revenues in the future than

we did year over year if you looked at it. So I

think the opportunity is greater. I really can't

tell you.

I'd like to help you out.

We added five new clients, Tim, year to year, in

the second landing side and our assets under loan

went up approximately a billion half although

market conditions really have turned back some of

the spread that we were traditionally making on

some of those loans. So some of our efforts were

diminished by the general market conditions.

Thank you very much.

Next we'll hear from Brad Moore

of Putnam Lovell.

Hi, good morning. A couple things

it first off, just to circle back to the guidance

again, you did speak to interest rates, but also

be curious to know, originally your flat equity

markets when you first put out your assumption, is

that still your assumption or what is the

assumption into your new guidance now.

The assumption is we're going

to be down where we are. I think we can still

make the guidance that we have out there.

Okay. And is that - is that your

expectation for 2003 as well with regard to the

equity markets?

We will hope that will knock

down, but right now we're expecting most of our

growth is going to be organic and from new sales

in '03.

From the fund flows you mentioned

this quarter can you give us some idea as to the

clients that contributed materially to those fund

flows? Was it largely BGI? And can you give us

some color as to who was responsible for the fund

flows?

I would say a portion of that

was BGI and another piece that was Agone American

Transaction (phonetic) business we discussed on

this or a previous call.

Is it safe to say the majority was

BGI?

No, I wouldn't say the

majority is BGI.

Okay. And then with regard to new

business, what's that pricing environment looking

like? Do you see any change there?

I think the pricing

environment is still competitive as we see every

time we're on the marketplace and at the end of

the day it still comes down in our opinion to the

service levels and, you know, and technology and

that's what we seem to be differentiating

ourselves in the sales and the marketplace.

Okay. So any significant downward

change in pricing or is it just variable like it

has been in prior quarters?

I think it's similar to prior

quarters, still competitive.

A couple of other things. Can you

give us a sense, then, with specifically with

regard to the value added revenue items, can you

give us more color as to the actual growth rates

for sec lining versus FX versus cash management.

Quarter over quarter or link

quarter?

Year over year.

Year over year, FX were up

51 percent for the quarter and security funding

were up 36 percent quarter over quarter. Six

month numbers were up 37 percent for FX and

29 percent securities lending.

And then finally can you give us

the amount of BGI revenue this quarter?

We won't disclose BGI

revenue.

Okay. Great. All right. Thank

you.

You're welcome.

Again, star one to be placed in

the queue for a question or comment. We'll next

hear from Carla Cooper of Robert W. Baird.

Good morning.

Hi Carla.

I note the small item value added

services but investment advisory actually shows

some spectacular growth. Could you tell us a

little comment on that?

That's what Merimac

(phonetic) mutual fund products, five money market

funds that we distribute to our institutional

customers as security lending customers and then

to the outside world for cash management. The

yields on those funds have really performed very

well over the last 18 months, and I think it

reflects some benefits we've gotten from that

yield with outside distribution as well as

reflects investment advisors pulling back out of

equities and using that cash vehicle as a holding

place where hopefully market conditions will

improve.

Great. And one other question I

think one of the questions you made on the last

conference call the amount of business buying

early in the year actually gets you to the point

where you're quite comfortable with guidance based

on the business you just won. Am I remembering

that correctly? Any update to that?

What's that question again,

Carla? I didn't understand that.

I thought what we said on the last

conference call was that the amount - the

significant amount of business that was signed

that's been signed so far in a year actually gives

you - brings you almost all the way to the point

where you could actually achieve the current

guidance even without signing new customers? Am I

remembering that correctly?

Yeah, that's probably

correct.

Okay. So all right. That was the

question. Thanks.

Next we'll hear from Thomas

Kanler (phonetic) of KBW investment bank.

Great quarter. A couple of

questions if I might, one for John, one for Kevin.

Can you help us understand what was the size of

the uptake in transaction volumes that you're

processing on a late quarter basis?

Sure. The processing was

up, I think, 36 percent in terms of dollars and

the volumes were pretty much up relatively the

same. That's link quarter annualized?

Not annualized?

The way transactions work is

we've had buy or sell a transaction. There's a

fee associated with that so we annualize that

item.

Okay. Second question. Would you

elaborate a little more what is the source of

positive change that creates new guidance up a few

pennies.

New guidance I think we

converted more asset on some of the new business

that we had expected, the markets haven't taken us

down as much as we had thought, that interest

margin remains strong. I think prior guidance was

they thought it was going to go up in the second

half of the year. Now it's not moving. And in

all those positive things, last to bring guidance

up.

I guess I'm trying to understand

the positive on the net income. If I look

correctly it's a little flat in the quarter and I

thought you guys were looking for a little higher

expectation than just income growth, so am I

correct to infer that the noninterest income

growth is actually better than you expected in

offsetting the flat and interest growth?

No, I would say we would

expect say we would expect that interest margin

remain strong, as I mentioned earlier in the call,

we prepaid some FHLD advances that costs a little

money to basically lock in some long term spread

for '03 and '04 and that's why the margin was off

a little bit and I think we'll see a little bit of

pickup from that next quarter.

That helpful, John. Kevin, just

some sort of a theoretical question, pick your

broken, the lady who has done such a good job of

running BGI stepped down for health reasons and

there's a team of management below them, but

there's been some discussion in the marketplace I

guess as to whether or not there is as much

pressure for management buyout or the unit would

be sold. Do you have any thoughts as to whether

or not her stepping down changes that outlook for

what's likely to happen there?

You know, I don't, and I

think if I did it would be really inappropriate

for me to comment. We do have a five year

contract with them with really no outs in that

contract and as you'll recall, we picked up the

300 odd people that went with the transaction and

have spent certainly significant resources in

converting that into this institution, so I think

we feel pretty secure with the relationship,

whether they aggressively pursue their management

buy out at this time or defer it, but I really

don't have any guidance that I can confirm for you

in terms of where they're going to go with that.

That's fair. Just a point of

clarification, if I may, when you say no outs,

what does that mean exactly?

Basically it's a no cut

contract. It's a five year deal with four years

left to run.

Thanks a bunch.

Yes.

And actually we have a follow-up

from Timothy Willi of A. G. Edwards.

Kevin, I guess I want a

theoretical question but you've had a lot more

experience in this business than myself and

probably others covering your name, but I think I

would be curious working your years of this

business in this type of environment that we've

volatile and we've now taken another leg down,

have you seen where this postpones decisions even

further or another enterprise that's moved fairly

far down the path, they continue to plug ahead,

you know, despite fairly volatile or quick changes

in market directions or, you know, has it been

your experience this will cause people to sort of

stop and reevaluate again?

No, I think we've found in

the past although it sounds lot of intuitive, I

think this is the time when a lot of people

investing the next dollar coming through the door

look strategically, look at costs, those costs

they this outsource and typically tends to be an

environment where we get the focus of the

strategic thinkers and the decision makers in the

organizations and typically they move more

aggressively, I think, in terms of closing

business or looking at the possibilities of

changing the way they do business.

Okay. So then it's actually sort

of speeds up the process or makes it more pressing

to kind of get the R and P and all that stuff wrapped

up and moved forward.

That's our feeling.

One more question on that note.

Could you refresh my memory on what kind of costs

are beared by, you know, your customers, whether

there is a conversion from one company to another,

any significant outlays they have to make or

painless from that perspective?

It's painless.

Next we have another question

from James Allen from JLS.

Great. Could you give us an idea

just when you talked about the back half in terms

of your guidance not going up what sort of market

expectations are you building in there? Are you

expecting improvements or a flat market?

We've got a flat market built

into that right now. As soon as the markets went

down, we went back and reforecasted and we're

comfortable with our guidance today based on our

reformed values.

And one other point I didn't see

in the press release, maybe it's there, if we

expensed options for EPS, what would EPS have

been?

For 2001, it would have been

let me see, I don't have that number right in

front of me, but would have been 18 percent off of

$1.53. Let me do a quick calculation. $1.35,

probably.

And does that - I take it it's

significantly smaller for this quarter; is that

correct?

Would have been $1.26, I'm

sorry.

I take it it's significantly less

for this quarter?

It would be if you were

looking at - actually no. It wouldn't be any

different unless the Black Shull's (phonetic)

calculation changes would take the value down. I

think it will take up from that if you had to

expense because the valuation probably would come

down a little bit.

But it's something approximately

15 percent, something like that?

Yes.

Something reasonable for a tech

company that's growing quickly?

Yes.

Thank you very much.

We'll next hear another follow-up

from Brad Moore.

Yes, just to be clear, on the

assets, you said that assets were up 19 billion

from new clients and I understood that those -

that those flows related to the four or five

clients you mentioned that you won last quarter.

Could you give us the names of clients that you've

won this quarter and therefore will show up in new

flows for next quarter?

We didn't win any additional

new business this quarter. The numbers we gave

you were for the conversions of the assets from

last quarter we announced and fund flows from

existing customers to this quarter.

Okay. And so - I mean is that a

little unusual, then, that you didn't win any new

clients during the quarter, in terms of your

historical velocity of new clients? Are you

saying the market is relating to that or just a

timing issue?

Just a timing issue, Brad.

But presumably, then, you were in

the bidding process, I think, as you said, with

seven or eight clients during the quarter and it's

your expectation that some of those are clients to

be signed earlier in the third quarter or should

they just be clients that you expect to come in

over the course of the entire quarter?

It's traditionally been our

policy to disclose them only when we win them.

Okay. Thank you.

That concludes our

question-and-answer session. A replay of this

call will be available starting at 11:00 central

today and will run through July 18th at midnight.

To access this replay please dial 719-457-0820 and

enter in the pass code of 718642. Again that

number is 719-457-0820 with a pass code of 718642.

This concludes today's conference call. Thank you

for your participation.