道富銀行 (STT) 2003 Q2 法說會逐字稿

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Good day everyone and welcome to the Investors Financial Services Corporation second quarter release conference call.

Today's call is being record 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.

Thank you for joining us on today's call.

We'll be making a number forward-looking statements which are based on management's assumptions and predictions 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 MD&A section of our most recent 10-Q and 10-K filings with the SEC.

I recommend that anyone listen to this call review these reports care three. because this call will be archived on our web site Q WW.IBTCO.com I want to emphasize for anyone listing at a later date that the statements made today are based on our assumptions as. today, July 16, 2003.

This 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 of the key points from the second quarter and then John Spinney will discuss our financial results in more detail the second quarter witnessed several important developments for Investors Financial Services.

As we announced three weeks ago we reported diluted operating EPS for the second quarter of 32 cents per share.

A penny ahead of consensuses estimates.

We also disclosed we were selected by Barclays investor Canada a to process approximately $22 billion in assets.

That we settled a REIT tax matter with the Massachusetts Department of Revenue and that the dispute was dismissed without our company making any payments.

Looking at the bottom line results in a little more detail, diluted operating EPS for the second quarter came in at 32 cents.

Up 10% on a [inaudible] basis, and up 6 cents or 23% from quarter 2 of last year.

Including the $6.7 million tax charge reversal we disclosed in June related to the settlement of or REIT tax matter with the Massachusetts Department of Revenue our GAAP EPS for the quarter came in at 42 cents.

In accordance with reg G we included both the GAAP and pro forma operating results in this morning's press release which you can access on the web site.

As of June 30th we processed approximately $897 billion of assets for our clients, up $113 billion from March 31st, 2003.

On a pro forma basis, including the new business associated with the BGI Canada outsourcing our assets processed as of June 30, 2003, would have been approximately $919 billion.

The BGI Canada business is scheduled to start converting during the third quarter of 2003 subject to regulatory approvals.

We converted approximately $5 billion in assets from existing clients during the quarter and lost $2 billion in assets as a result of the expiration of our contract with city street, a joint venture of city group and State Street bank, and experienced market appreciation and client fund flows of $110 billion during the quarter.

The current status of our new business pipeline remains medium.

We believe that the positive capital market improvement environment during the second quarter has created some momentum on several new business opportunities.

We feel that this shift in market sentiment may lead to shorter decision cycles and create opportunities to close new business by the end of 2003.

To summarize, we again delivered excellent results for our investors during the second quarter of 2003.

These results were driven by our ability to sell existing clients, our continued focus on prudent expense management and strong equity and fixed income market environments.

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

Thank you and good morning.

As Kevin mentioned, second quarter diluted operating EPS came in at 32 cents up 3 cents or 10% on a link quarter basis.

Our diluted operating EPS of 32 cents represents a 23% increase over our second quarter 2002 diluted EPS of 26 cents.

From a GAAP perspective we earned 42 cents for the quarter as a result of the 6.7 million or 10-cent a share reversal of a charge resulting from our settlement of the REIT tax matter with the Commonwealth of Massachusetts.

Net operating revenue which is made up of fee income, transaction income and net interest income increased 7% link quarter and 11% over the same quarter of last year.

Each of our revenue sources represents a component of our compensation for providing asset processing services to our clients.

Net interest income is one of these components and results are investing the residual cash of our asset processing client who use our balance sheet as a convenient way to invest their excess cash.

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

These three revenue components create a natural hedge for our business mad model which has been one of the factors enabling us to succeed in a variety of market environments.

The breakdown have our revenue stream for the second quarter 2003 was 52% asset based, 31% net interest based and 17% transaction based.

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

Asset servicing fees increased 13% link quarter in line with the major indices and also due to higher transaction volumes from clients.

Net interest income decreased 3% link quarter primarily due to an asset liability strategy which we also employed in 2002 if of prepaying a high yielding FHLD advance with a new borrowing and a lower rate and matching that lower rate borrowing against fixed rate assets of the same maturity We continued to maintain strong and interest margin in spread, despite flattening [inaudible] curve primarily as a result of strong client funding.

The link quarter net margin decreased by 26 basis points to 208 while the linked quarter interest rates spread contracted by 25 basis points to 1.97%.

Compared to the same quarter of last year, net interest income was up 11%, mostly due to the increased size of our balance sheet partially offset by a decrease in rates.

Approximately 98% of our investment portfolio is invested in securities backed by the U.S. government and/or AAA rated securities.

We continue to run a closely matched balance sheet with an asset duration of approximately 1.2 years and liability duration of approximately 1 year.

Transaction driven income which we include our and auxiliary services such as security lending, foreign exchange fees and cash management fees increased 27% link quarter driven primarily by a strong rise in our FX business when compared to the first quarter of 2003.

Regarding FX, new clients further penetration of existing clients, high transaction volumes, and volatility in the currencies traded by our clients contributed to the strong performance.

Securities lending was up link quarter due to higher equity market values in the international dividend payment season.

On a year-over year basis transaction driven income rows 32% driven by strong increases in FX and cash management fees.

Total operating expenses were up 6% linked quarter compared to our 7% increase in revenue.

Comp and benefits expense rows by 2% on a link quarter basis, mainly due to higher bonus accruals as a result of the company's strong performance in the second quarter offset by lower head count and lower payroll tax accruals.

Technology and telecommunications expense was up 3% link quarter due to increased spending on projects to meet client needs, increase our internal efficiency and reduce risk.

Transaction processing was up 40% link quarter due to higher transaction volume in the second quarter of '03 versus the first quarter of 03.

Depreciation and amortization increased 9% link quarter as projects that were previously capitalized were placed in the service during the second quarter of 03.

Professional fees were up 23% a link quarter basis as a result of cost related to the REIT settlement, dismissal of the [MOPEX] (ph.) case and the California overtime lawsuit.

On a year-over-year basis our operating expenses increased 6% compared to our 11% increase in revenue.

Despite the upturn in equity and fixed income values we'll continue to maintain strict cost controls until we see recurring positive economic indicators including new business wins and sustained levels in the capital markets.

As always we'll only increase our cost structure to support the addition of new business.

As most of you know we accrued a tax liability on our balance sheet and a tax expense on our income statement for the quarter ended March 31st, 2003, related to potential tax liabilities of the bank.

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

Last month the bank and the Massachusetts Department of Revenue entered into a settlement agreement that obligated the bank to pay 50% of its outstanding tax liability including interest.

As a result of this settlement agreement, we recognize an income tax benefit during the second quarter of 2003 of $6.7 million or ten cents a share.

We are cautiously optimistic about the capital markets in interest rate environment as such we continue to expect to achieve GAAP earnings per share of $1.19 for the year ended December 31st 2003 there when represents our original guidance of $1.30 per share reduced by net tax charge of 11 cents as previously described.

We remain comfortable with our long-term growth rate of 25% in EPS.

I'd now like to open up the call to your questions.

Operator?

Thank you the question and answer session will be conducted electron electronically.

If you would look to ask a question, you would may do so by press than the star key followed by the digit 1 on your touch tone telephone.

Make sure you're mute is ever function is turned off to allow your signal to reach our equipment.

Again, that's star 1 if you would like to ask a question.

We'll take our first question from Jon Arfstrom is from RBC Capital Markets.

Morning guys.

Morning Jon.

a question for you on value added, you talked about the international dividend tax payment season.

I guess there are other things in there.

Can you talk about who it performed towards the end of the quarter and for the first two weeks has that strength in the business continued?

Are you talking SEC lending specifically, Jon?

FX and SEC lending.

the first two weeks of this quarter?

Yep.

And then how it perform towards the tail end of the second quarter it.

Performed really well toward the sail end of the second quarter.

We got a lot of activity the last two weeks of June on FX, and in securities lending after the rate cut we'll benefit slightly going into this third quarter but obviously, as the margin compresses there and collateral, we buy new additional collateral at lower rates, that will compress that.

I think going forward FX will probably be a little bit lower than it was this quarter.

We had the best month of our life last month of about 4-1/2 million in revenue, the best day of our life last month as well, so I would expect that it would be -- it would come off that a little bit, but I still think that we have strong outlook for the rest of the year.

Okay.

On your restructuring of the liabilities, I guess in the past you shared a few more details.

Are you willing to do that in term of the penalty paid and the rate and the maturity of what you --

Yeah, basically we prepaid I think $100 million advance.

We incurred a $1.1 million penalty which runs through interest expense.

Refinanced that were with a lower borrowing, put on some fixed rate assets, and basically locked in 200 basis point spread over the life of that borrowing.

It's relatively small , $100 million on a half million dollar balance sheet.

Fair enough.

On '04 I know you haven't commented on that, but do you still feel that bids on what you neonow you can stick with a 25% growth rate?

That's correct.

Okay.

Thank you.

Yep.

and we'll go to our next question that comes from Joel Gomberg of William Blair and Company.

Good morning.

Maybe you can flesh out a little bit what you did for State, for City Street and then where the new business came from existing customers.

Yeah.

On City Street we did custody fund accounting.

It was I want to say probably less than a million dollars of revenue on an annualized basis.

And obviously, you know, they're a competitor of ours and when the contract was up there was no surprise on our front that that was going to move back to State Street.

That's reflected in our guidance for this year and our expectations for next year.

And what was the second part of that question, Joel?

I'm sorry.

On new business from existing customers.

On the new business from existing customers we did $5 billion of assets.

The biggest chunk of that was from Eaton advance, a couple billion dollars, some new funds.

Anything else, Mr. Gomberg?

No, that's it.

Thanks.

As a reminder you may press star 1 if you do have a question, that is star 1 to ask a question.

We'll go back to Brad Moore of Putnam Lovell NBF.

Good morning.

A couple things.

First, I wanted to know if you can give us a little bit more color on the operating environment.

You did mention that you were sensing some improvement in the behavior of the target market, and I was just curious to understand if you can give us a little bit more about who it is.

Is it mostly existing customers?

You have seen a fair amount of new customers in that.

And anything as to the timing of what that activity might look like.

You know, I think the pipeline still remains medium.

We've definitely seen a pickup in interest in our services as the markets have recovered and investment managers have, you know, refocus owed strategic things look outsourcing and looking at their service providers, and our salespeople have had many more meetings with prospects, so I think what we're seeing is a general upturn in calls, in meetings with our salespeople, moving things that were in the pipeline forward, and we've got a handful of outsourcing deals that I think one or two of those have the possibility of closing by the end of this year or early ‘04.

and would you characterize those as small, medium or large?

I think they're sizable.

Okay.

And it would be the full range of services or what do you see in terms of client interest in term of the menu of services?

I think, you know, everybody looks at the full complement of services, Brad, very little people focus solely just on custody or fund accounting.

Secondly can you gives a little bit of color on where you think the contraction in our net interest margin on a go-forward basis.

Right now our sensitivity to a 200 basis point increase in rates parallel shift in the curve is about 6.7% reduction in net interest income so net interest income is about 30%, that would equate to roughly 2%, and 2% of our top line is about $8 million, so worst case scenario would be 8 cents over a 12-month period.

We don't feel like that -- we've got much risk at all in terms of interest rates moving up right now.

Did you say that assumed a parallel shift?

Yeah, it's a parallel shift over 12 months.

and if it was a flattening curve, would how would that impact the assumption?

a flattening curve would contract our net interest income slight but I don't have that number at my finger tips.

All right.

Thanks.

and now we'll go to Carla Cooper of Robert W. Baird.

Good morning.

I wondered if you could talk a little bit just maybe update us on your thinking vis-à-vis the $1.30.

Clearly at the beginning of the year I would have thought anyway that the components of that would have been a little different.

Is it fair to say now that the $1.30 is likely to come a bit more from asset administration and value added services and a little less from net interest income?

I think, Carla, from a geography perspective net interest income is going to be a little slightly lower than the $1.60 we talk about earlier.

You know, given the markets, if they're sustainable levels versus choppy levels, we'll basically have more coming from the mutual fund administration line, and I think we've done a very good job managing expenses than we did this quarter as a result of the out performance.

We booked up bonus accruals that we needed to book to offset the earnings that we put up for the quarter.

But I would say from a geography perspective net interest income a little bit less than $1.60.

Revenues and Mutual fund fees with a market stab will stay at the levels they are today and value added can like I said FX is usually a little bit slower over the summertime so that will probe come back in the third quarter to a more reasonable level of, you know, 2-1/2 to $3 million or something like that a month.

Got I and then any other -- to my recollection you talk about the balance sheet sort of $8 billion being a number that we should -- I had in my head anyway for '03.

Is that still looking a bit bigger than that or are you still looking around something for $8 billion for the year?

I think it's a little bit higher than that like 8.3, 8.5, something like that in the neighborhood average balance sheet.

for this quarter but I think previously you talk about of where you thought you could end the year.

Yeah, it will probable be I a little bit higher than that.

and then finally as regards competition, are you seeing, you know, anything different a long those lines?

And I guess specifically also, you know, new discussion of pricing as these investment managers begin to sort of re look at outsourcing services?

I think from a pricing perspective there hasn't been a lot of pricing pressure.

I think we've said that historically on the past calls.

I think given where our pricing is in the marketplace, being less than a basis point in some of the core custody services, is not a lot of room to take that fee down, and I think, you know, people typically look at service levels and at the end of the day, with our number one rankings.

A.In global custodian two years in a row, I think people focus on quality for the price, and that's why we get very little price pressure.

Thanks.

Yep.

and now we'll go to Tim Willi of AG Edwards and Sons.

Good morning.

I was wondering if on the pipeline discussion if you could give any color when you talk about the or look at it, the pipeline for perspective new customers versus existing customers, and just if you are seeing any change in focus in activity from people you're currently doing work with and, you know, their willingness to make additional decisions and give you more assets or does that remain relatively stable and you're really just focusing on brand new entities when you talk about the pipelines?

I think, Tim, you know, we don't talk about all the new business that our clients give us every single month.

But we do a tremendous amount of growth year in and year out from lines client that start new funds and new products similar to the piece of business that Eaton Vance started this quarter.

So year over year we've continued to see our clients put on new product and put on product that fits into the current marketplace or whatever's being bought in the marketplace, so that's continued to drive one part of the sales side.

And on the other side is really the new client business, and as I said earlier I think with the markets being up, folks are spending more time analyzing their vendors and the service levels and talking to our folks, and I think we'll see some more movement there, you know, in the next two quarters.

Okay.

So it's possible that the kind of wind win you just could the got from Barclays where they gave you a nice chunk of business and current customer feasible that you may get some other customers where you get lump sums like that versus just somebody opening up a new fund, but clearly you're also hitting the payment very hard on people you don't deal with yet.

Yeah, I mean on both fronts, we're attacking it on both fronts, and we're seeing positive movement on both fronts.

Okay.

Thank you.

Ands a reminder you may press star 1 to ask your question.

That is star 1 if you would like to ask a question.

We'll go next to Tom McCandles of Keefe, Bruyette & Woods brokerage.

Good morning.

Quick question.

Can you remind us of what the underlying assumptions were for the EPS guidance for this year and next year, assumptions regarding asset values?

Asset values we typically run with no market appreciation assumptions, and right now, as I said, we're cautiously optimistic.

The markets may be up 15% for the quarter.

I don't know how they're going to perform for the next six months.

So, you know, we're cautious in guiding anywhere off the $1.30 right now.

With respect to interest rates, we have interest rates flat to the end of '04, and then going up 300 over 18 months, 300 basis point over 18 months.

Great.

And are you seeing any pickup in activity given the head count reduction effort over at State Street either in hue hires or in customer detexts?

None.

Fair enough.

Thanks.

and this concludes our question and answer session.

A replay of this call will be available starting at 12:00 noon eastern today and will run through July 22 at midnight central time.

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

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This concludes today's conference p thank you all for your participation.