道富銀行 (STT) 2003 Q1 法說會逐字稿

Good day, everyone.

Welcome to the Investor Financial Services Corporation first quarter earnings release conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Joe DeCristofaro.

Please go ahead sir.

Thanks operator and thank you for joining us on today’s call.

We'll be making a number of forward-looking statements which is based on management's assumptions and predictions as of today.

The company's actual results may differ materially from our current prediction due to any one of a number of factors.

Information regarding the factors that may affect our actual results is set fort in the MD&A section of our most recent 10-K.

I recommend that anyone listening to this call review this report carefully.

Because this call will be archived on our website, www.IBTCO.com, I want to emphasize again that anyone listening at the later day that the statements made today are based on our assumptions as of today, April 10th, 2003.

The assumption may change but recording of this call will not be updated.

Joining us on today’s call are Kevin Sheehan, Chairman and CFO;

Mike Roger, President; and John Spinney, Chief Financial Officer.

I'll now turn the call over to Kevin Sheehan.

Thanks, Joe.

Good morning.

I'll begin by reviewing some of the key points of the first quarter and John Spinney will discuss our financial results in more detail.

Diluted EPS for the first quarter came in at 29 cents, up 4% on the link quarter basis and up 5 cents, or 21%, from quarter one of last year.

Including the $13.9 million tax charge we disclosed in March related to the retroactive tax law change.

Our GAAP EPS for the quarter came in at 8 cents.

In accordance with regular G, we included GAAP and pro forma operating results in this morning's press release, which you can access on our website.

As of March 31st we processed approximately 784 billion of assets for our client, essentially flat with the 785 billion we processed as of December 31st, 2002.

During the first quarter of 2003, the S&P 500 declined 3.6%, the Dow dropped 4.2%, the NASDAQ was, basically, flat, rising 0.4%.

The first quarter of 2003 represented a continuation of the challenging capital markets environment we witnessed in the first quarter of '02.

As such, we continue to manage our costs down during the quarter, while continuing to develop new sales opportunities.

We converted approximately 4 billion in assets from existing clients during the quarter.

Market depreciation and client fund flows related in a $5 billion decrease in our assets process during the quarter.

During the first quarter of 2003 we were selected as a custodian, fund accountant, fund administrator for the [Giewenhiem] real estate investment trust.

We began servicing these products in early April of 2003.

The current status of our pipeline remains medium, as we have plenty of potential opportunity for new business.

That being said, we would say the first quarter saw some of the same sluggishness and corporate decision making process that we witnessed in the first quarter of '02.

To summarize, we again delivered solid results for our Investors during the first quarter 2003 in a difficult economic environment.

These were sales driven by a diversified revenue mix and strict attention to cost controls.

Now, I'll turn the call over to John Spinney who will review the quarter's financial results in more detail.

Good morning.

As Kevin mentioned, first quarter diluted operating EPS came at 29 cents a share up 1 cents or 4 cents on a link quarter basis.

Our diluted operating EPS at 29 cents representing a 21% increase over our first quarter 2002 EPS of 24 cents.

From a GAAP perspective we earned 8 cents for the quarter as a result of 13.9 million or 21-cent a share charge resulting from the retroactive tax law change by the Commonwealth of Massachusetts.

Net operating revenue which, is made up of net interest income, fee income and transaction income increased 1% over the quarter and 7% over the same quarter of last year.

For financial statement presentation purposes we report two components of our revenue.

Net interest income and fee income which include our transaction based fees.

I would like to stress that each of our revenue sources derived from the same core securities processing business.

We do not gather deposits from our own sake like a retail bank.

Instead we generate net interest income by investing the residual cash to our asset processing clients, view as our balance sheet as a convenient way to invest excess cash.

As I mentioned before we generate fees based on assets under administration, net interest income and the number of transaction generated by our clients.

It has been our experience that during market downturns the net interest income and transaction volumes typically increasing providing a hedge to our asset sensitive revenues.

The break down of the revenue stream for the first quarter of ’03 was 51% asset base, 35% net interest income and 14% transaction based.

The diversified revenue stream contributes the resiliency of our business model in the difficult capital market environment.

I'll now walk through the significant income and expense components in more detail.

Core asset based fee income declined 3% link quarter in line with the major induces and due to lower transaction volumes from clients.

Net interest income increased 5% in quarter due to the growth of our balance sheet.

We continue to maintain healthy net interest margin and spread.

The link quarter interest rate spread increased by two basis points to 2.22% while the link quarter net interest margin contracted by one basis point to 2.34%.

Compared to the same quarter last year, net interest income was up 10% due to increase size of our balance sheet.

Approximately 98% of our investment portfolios invested in securities backed by the U.S. government and to our AAA related securities.

As a result, we been able to avoid credit losses and maintain strong net interest income.

Turning from revenue to the fundamental health of our business.

Our ability to win business and ability of our client to sell additional products, thus generating fund flows, has allowed us to continue to minimize the impact of the three year market downturn.

Our [Inaudible] pricing structure for asset based fees has helped us to stem the broader market downturn.

As stated on our last call, we have decrement the prices schedule for asset base fees as asset values deteriorate revenue only impacted by the asset decline of the marginal rate.

Transaction driven income, which we include our services such as securities lending, foreign exchange fees, and cash management fees increased 7% in the quarter driven by a strong rise in the effect, sweep, and investment advisory fees compared to the fourth quarter 2002.

Securities lending was down link quarter due to compressed spreads and depressed market conditions.

On a year-over-year basis, transaction driven income rose 19%, again driven by strong increases in [Inaudible] sweep and investment advisory fees.

Total operating expenses were essentially flatly for the quarter.

Computations and benefits expense rose by 8% on a link quarter mainly due to bonus and payroll tax accruals.

Technology and telecommunications expense was down 23%, link quarter, largely due to reduced use of contract programmer as a result of the completion of BGI integration, a one-time lease bio payment on PC’s made in the fourth quarter 2002 in debt reduce and future expense levels and lower EDS expense.

Transaction processing was down 11% link quarter due to lower transaction levels in the first quarter of 2003 versus the fourth quarter 2002.

Depreciation and amortization increased 17% link quarter as projects that were previously capitalized were replaced in service in the first quarter of 2003-.

Professional fees down 21% on a link quarter basis as a result of the completion of the BGI integration and lower tax and legal expenses in the first quarter of 2003.

Finally, other operating expenses were down significantly on a link quarter basis due to strict management and discretionary expenses.

On a year-over-year basis our operating expenses increased 3%, compared to our 7% increase in revenue.

Our compensation expense declined slightly on year over year controlled headcount and lower bonus accruals.

Technology expenditures fell as a result of the completion of BGI integration and a new [prepayment] procedure designed to reduce cost without compromising functionality.

Year-over-year increase in our expense structure were concentrated on occupancy has increased our office space in the middle of 2002 in Boston, and double in first quarter in 2003 despite the growth of our business.

And depreciation as previously capitalized projects replaced in service.

Again other operating expenses were down significantly due to strict management of discretionary expenses.

As a general firm policy, we continue to maintain strict cost control especially in the face of weakness in the capital market.

We increase our cost structure only to support the addition of new business.

As we previously disclosed, during 2002 we received from the Department of Revenue the Commonwealth of Massachusetts notices of intent – notices of assessment excuse me aggregating 10.9 million for state excise taxes and 1.2 million for interest related to the bank's 1999 through 2001 tax years.

The basis for this assessment was the DOR's contention that the dividend distribution from [Inaudible] are fully taxable in Massachusetts and not eligible for the dividends received at auction taken by the bank.

A March 5th, 2003, the governor of Massachusetts signed into law new retroactive legislation that amended Massachusetts law to expressly disallow the deduction dividends received from REET back to 1999.

We believe that this imposition of a retroactive tax is unconstitutional and intend to challenge the legality of this new legislation and continue to appeal and notices of assessment mentioned above.

However, U.S generally accepts the accounting principals required a company to account for the taxes and interest imposed by the new law at the time of its enactment.

Accordingly we accrued our tax liability on our balance sheet and tax expenses on the income sheet for the quarter ended March 31st, 2003 related to the potential tax liability to the bank under a new statute for tax years 1999 through 2002.

The affect of this accrual reduced our net income for the first quarter of 2003 by approximate by 13.9 million or 21 cents a share.

In addition the bank seize deduction the dividend received as much holding on real-estate investment trust in 2003.

Resulting in a further reduction in our consolidated net income in 2003 of approximately $800,000 or 1.2 cents per share.

Our 2003 guidance of $1.30 in operating EPS includes the effect of ceasing dividend received reductions.

The 13.9 million tax accrual is a non-cash charge, which does not adversely affect our current operations or our business outlook for 2003, although it will reduce our GAAP earnings per share this year.

Despite the continued challenging capital market environment we continue to expect to achieve GAAP earnings per share of $1.09 for the year ended December 31st, 2003, which represents our original guidance of $1.30 per share reduced by the charge previously described.

The guidance assumes no market appreciation.

In other words, absent and another adverse and another severe, sustained down downturn in the equity markets may come in our 2003 guidance.

I would now like to open up the call to your questions.

Thank you.

The question-and-answer session will be conducted electronically today.

If you would like to ask a question, you can signal us by pressing star 1 on your touchtone telephone.

If you are using a speaker phone, we ask that you please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, that is star 1 to ask a question.

We'll pause for just a moment to give everyone an opportunity to signal for questions.

Our first question comes from RBC Capital Markets, Jon Afrstrom.

Good morning, guys.

Good morning

On your new business, can you tell us how big it is and a little bit more about it?

Was that [Giewenhiem], Jon?

Yeah.

It is a few real estate investment trust that is will be approximately $4-500million in assets to start

Also, can you talk a little bit about maybe the mood of your sales force?

I know you guys always talk about how sales is the key to achieving in your numbers.

I'm curious what your sales force is focused on now?

Is it still trying to accelerate what's in the pine line?

Or are they going back to existing customers?

What are they focused on?

I think they're always focused on all of those fronts.

We've seen a fair amount of business from existing customers.

That's what we've been able to close and convert in the first quarter.

There are more RFPs coming in that we're filling out.

That's attractive.

We're still trying to bring some of those RFPs that have been out there for while to conclusion and book that business.

I think they're active on all three fronts.

I think we sense some bar in the hesitancy to move business.

It's going to take a lot to get things moving.

I think we still feel comfortable with respect to our earnings estimates based on where we are today.

Then you talk about the market taking away 5 billion in assets for the quarter.

The other 4 billion, that's new client flows.

Yeah.

Those were new products that were launched by a handful of client during the quarter Jon.

Okay and then can you go over your rate assumptions and market assumptions for your current guidance?

Our rate assumptions are [Inaudible] 125 to the end of 2003 and then a 275 basis point rise in the rate over the next 24 months, I believe, after that

Flattish equity and fixed income markets?

That's correct

Thanks, guys

Yeah.

Up next, we'll hear from Tim Willi from A.G. Edwards.

Good morning.

I have two questions.

First, I wanted to ask about the tax rate, John.

I can't remember if I heard you correctly or if you addressed it.

Is the core rate we're seeing now what it should be after going forward after you get through the dividend deduction issue?

Tim I would use a 31.5% effective rate now.

And the second question, on the mix of the assets that you have right now, is there anyway to sort of give a feel what would you -- you would view as retail or, I guess, individual asset that is are subject to withdrawals or inflows versus, the maybe, like the stable kind of pension endowment foundation money?

Any kind of feel you can give us for that?

Well, I would say that our assets are spread across many areas.

We do have a lot of retirement-type assets.

That creates stability and flows every single year.

I don't have a breakout by type.

Okay and I guess I'm also kind of curious, do you have any insight or thought on this issue peopling are talking about pension funds may be having to receive additional contribution funds sometime in the next year or so?

Are you hearing that from customers as you're dealing with them?

I think a couple of our customers are bullish they're going to pick up some additional contributions because of that new funding.

Okay great thank you.

Our next question will come from Cassandra Toroian from Cohen Brothers.

Hi.

I'm sorry.

My question was answered already.

Thank you, Cassandra.

As a reminder, to signal for questions, it is star 1 on your touchtone telephone.

Moving on, we'll hear from Brad Moore from Putnam Lovell.

Hi.

Good morning.

Can you just repeat for me the [Giewganhiem], did you say the installation would occur in April'03 or did you say the installation would begin the installation at that point?

It starts in April of '03.

There are three or four funds related to that, Brad.

Three, excuse me.

That would take three to six months to install that?

Probably less than that.

At least three month.

Did you say that would be -- it is both a core as well as value ad services.

That’s primarily custody funding, accounting fund and admin.

Any excess cash balance that is will flow to us under the contract.

Okay.

Could you give us a headcount as of March 31, and as of 12/31?

Head count at March 31 is 2512.

At 12/31 it was 2591, down 79.

Anything to update on BGI in terms of penetrating that business with more value ad services or is it pretty much status quo?

We continue to make progress with them.

In '02 we moved the I-share product, the global I-share product to us.

We talked about that in the past.

We created a new fixed EPS income with them, again we talked with them in the past.

We made some progress with BGI on using us for [FX].

It is still an exciting relationship for us.

Last thing, I was curious if you can update us on the rate sensitivity to your balance sheet

200 basis point parallel shift would basically reduce the net income interest by 6% right now.

Great.

Thanks.

Move on, we'll hear from Carla Cooper from Robert W. Baird.

Yes.

Can you hear me okay?

Yes.

Good morning, Carla.

Can you talk about in the past you paid some penalties in conjunction with your borrowings to change the rates that you were paying.

Did you pay any of those in this quarter?

No, we didn't, Carla.

Okay and then, also, back to the [Barically's].

Can you give us any update on the class action lawsuit that was filed in California?

Anything in the way of timing or can you say anything about the maximum amount you might be subject to?

I think we're in the process of going through discovery and that process.

I think the key thing to recognize is we took that business over in May of '01.

Our liability runs from when we took it over to when we changed the structure of overtime process, which was about a year later, a year and three months later.

It only applies to 70 individuals or people in the class.

We don't think it's going to have a material effect on our P&L.

We haven't quantified it or disclosed it yet.

I don't think it's going to have a severe affect to us.

Okay.

And then, finally, just on net interest income and your expectations for that for the year.

Did anything change vis-à-vis your expectations when you did this call three months ago?

Have things in the market stayed in line with those expectations has there been anything unexpected, you know, what's happened versus what you had been expecting?

No.

I think we're still targeting 160 million of net interest income.

Nothing has changed.

Finally, your borrowings were up in March versus December.

Can you point to any specific reason for that?

Do you expect them to be lower or higher next quarter?

There is seasonality in the funding.

From time to time it goes up and down.

During this quarter, deposits went down little bit.

They typically flow in and out.

We run the balance sheet at a particular asset level.

We use borrowed fund to keep ourselves from having to shrink the balance sheet and to grow the balance sheet.

It allows us flexibility for deposit coming in and out without affecting our results of operations.

Thank you.

As a final reminder, it is star 1 on your touchtone telephone to ask a question.

Moving on we'll hear from Matthew Clark with Keefe Bruyette and Woods.

Good morning.

Good morning.

Just a quick question on the securities lending business.

Can you discuss what kind of activity you saw there in the first quarter and what the outlook is there?

I think the securities lending was offal bit in the first quarter, primarily as a result of the compression and spreads in the reinvestment side of that business, as well as the market values and coming down from December 31st.

That contributed to the change there.

Nothing else earth shattering to talk about there.

Your outlook there?

Our outlook is pretty much where it stands right now.

I think we'll continue to rate a current rate it runs at now.

I don't think it's going to go down or up.

Thank you.

Our next question will come from Kyle Seemonairra (ph) from Tprice.

Hey guys.

Hey Kyle, how are you.

I am pretty good, hey one quick question on your expectation on your interest earnings assets by year end.

You said that you may expect it to go to 8 billion.

I want to see if that's still consistent.

Secondly, on net interest margin, you had previously said it could close as 1.85%.

I want your expectations for that, being it held in there pretty well.

I think it's still close to 8 billion at the end of the year on the balance sheet.

Whether we get to one eight five, I don't think we're going to get there but it could.

I doubt it.

What are -- are you doing anything in terms of swaps or swaps in terms of offsetting that?

I know that some people expected to come down much more than it did.

In terms of what we use swaps for in our portfolio is to really hedge our short-term liabilities and, really, create long-term funding to match the asset portfolio from an asset liabilities management perspective.

And as we see rate opportunity, we'll add swaps to our portfolio.

Okay my last question on your current customer assets, I guess you're less than 10% penetrated on current customer assets.

Do you see new opportunities to win new business from those clients?

Definitely.

We had plenty of opportunities of existing clients that are in the process of negotiating, et cetera.

Okay.

Thank you, guys.

Up next from Arbor Capital we hear from Rick Liggit (ph).

Good morning.

Don't take this defensively, please.

Is it fair to characterize the quarter we've had as followings.

Closing sale cycle was more difficult, new business didn't quiet meet the targets.

You made the EPS because you got a terrific business model, you reduced business expenses than you expected or then were estimated I should.

And you fairly aggressively grew the balance sheet to offset the revenue softness?

It's not a bad characterization.

But I would not say that we aggressively grew the balance sheet to offset the loss in revenues.

If I look back at seasonality in terms of short-term borrowings first quarter, it is in line with historic?

Yeah, I would say so.

Going from that, as you look forward and we focus just on sustainability of revenue growth to increased shareholder wealth over time, you've always been a high organic growth company.

Any adjustment to your goals?

I've certainly heard this morning that EPS we're fine with for this year.

I haven't heard so much about revenue.

Yeah.

I mean, I think we say we can make the $1.30 this year, given what we have today and we are comfortable with and what is coming.

I think we figure the $1.30 in terms of operating income is locked up.

I think what we think is if we get some faring in the new business side of this exercise and, certainly, we have a high level of interest, the potential is to do even better so.

So in the past you've talked about 25% organic growth.

Yeah.

That implies, you know, 20% plus kind of top line growth?

Right.

Is that in the cards for this year?

I don't think the $1.30 is based on 20% top line growth.

How about looking out longer term?

You know we're still hanging tight on our long-term projections of a 25% EPS growth rate.

Okay.

Thanks.

We'll take a follow-up question from Tim Willi from A.G. Edwards.

I had a question about the sales environment.

I'm curious to extent if you want to comment in a public forum with two of your bigger competitors, Bank of New York and State Street are in the throws of integrating fairly sizable deals.

I'm curious.

When you look at the pipeline and talk about some [Inaudible] and seeing what may be little more encouraging activity.

Would you be willing to fathom whether any of them might be attributable to lack of focus or those other companies having their hands full?

I don't like to comment on the results of their operations.

Both of them are digesting fairly significant pieces of business.

I think most of the business that we're seeing today is not necessarily predicated on any of those activities, but just a general desire on the part of the sales participants there to either broaden their service levels or actually outsource their back office operations.

That seems to be -- that seems to be the continuing themes.

Okay.

Thank you.

from Robert W. Baird, a follow-up question from Carla Cooper.

One final question.

You mentioned that expense accrual was a little lower in the quarter.

I wondered.

Are you accruing at a fairly straight line rate as you look at the $1.30 or should we expect more accruals in subsequent quarters as sort of a catch up?

I think what I mentioned in the call was we had higher bonus accruals in Q1 versus Q4.

When you start the New Year from a payroll tax perspective, everybody has to reload on FICA.

You have a big accrual in the first quart for that.

Generally, Carla, across the across-the-board, with the exception of depreciation and occupancy expense, we'll try to keep those tempered for the remainder of the year.

Okay.

Thanks.

This does conclude our question-and-answer session.

A replay of the call will be available starting 12:00 noon eastern time today and will run through April 16th, midnight central time.

To access, please dial 719-719-457-0820 and enter the pass cord 534670.

Again, 719-457-0820 with a pass code of 534670.

This does conclude our teleconference for today.

We'd like to thank you all for your participation