道富銀行 (STT) 2003 Q4 法說會逐字稿

Good day, everyone and welcome to the Investors Financial Services Corporation fourth 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.

Thank you for joining us on today's call.

We will be making a number of forward-looking statements, which are based on management's assumptions and prediction 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 listening to this call review these reports carefully.

Because this call will be archived on our Web site, www.IBTCO.com, I want to emphasize again for anyone listening at a later date that the statements made today are based our assumptions as of today, January 22, 2004.

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 Roger, 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 fourth quarter and year ended 2003, and then John Spinney will discuss our financial results in more detail.

Investors Financial Services recorded extremely impressive results for the fourth quarter of 2003.

Diluted EPS for the quarter came in at 48 cents, up 20% on linked quarter basis, and up 20 cents or 71% from quarter four of last year.

For all of 2003, diluted operating EPS came in at $1.49, up 43% from 104 in 2002.

As of December 31, we processed approximately 1.06 trillion of assets for our clients, up 101 billion from the September 30, 2003.

For a little more detail on our assets processed, we converted about 5 billion in assets from numerous existing clients during the quarter, including Aegon, BGI USA, Eaton Vance, Goldman Sachs and Mass Mutual.

We lost approximately 1 billion in assets during the fourth quarter as a result of Standish (ph), which was acquired by Mellon not renewing its contract with us.

We also experienced market appreciation client flows of 97 billion during the quarter.

As announced on our previous conference call, we were selected as custodian, fund accountant and fund administrator for BGI Canada last year.

The conversion to our platform is complete.

We were also appointed custodian of fund account for the Charles Schwab Trust Company 401- K plans, which will convert during the first quarter of 2004.

In addition, we grew our institutional custody business by signing several new advisory clients in the fourth quarter.

The strong rise in assets processed that we witnessed this year has resulted from both our ability to sell new business, 41 billion during 2003, and the rise of equity asset values since the spring of 2003.

Directly related to the growth of our processing business is growth in our balance sheet, which on an average basis grew 30% from last year's fourth quarter to this year's fourth quarter.

Strong client funding drove this balance sheet growth.

The current status of our new business pipeline remains medium.

We believe that the sustained upturn in the capital markets has driven the closing of wins we have disclosed on this and prior calls.

Going in to 2004 we feel the shift in market sentiment should lead to opportunities to close new business.

To summarize, we again delivered excellent results for our investors during the fourth quarter, and year ended 2003.

These results were driven by our ability to sell new and existing clients, solid equity market performance and our continued focus on prudent expense management.

I will turn the call over to John Spinney, who will review the quarters' financial results in more detail.

Good morning.

As Kevin mentioned, fourth quarter diluted earnings per share came in at 48 cents, up 8 cents or 20% on linked quarter basis.

Our diluted earnings per share of 48 cents represents a 71% increase over our fourth quarter 2002 diluted earnings per share of 28 cents.

For the entire year of 2003, diluted operating earnings per share came in at $1.49, up 43% from $1.04 in 2002.

On a year-over-year basis, our fourth quarter net operating revenue increased 18% while our operating expenses remained flat.

Exhibiting the earnings growth potential and inherent leverage in our model.

On a linked quarter basis, fourth quarter revenue increased to 10% versus a 5% increase in our cost structure.

Total 2003 revenue rose 11% to 489 million from 440 million in 2002, while operating expenses rose 1% to 345 million from 341 million in 2002.

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

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

We generate revenues based on assets under administration, the number of transactions generated by our clients in net interest income.

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

The breakdown of our revenue stream for the fourth quarter of 2003 was 48% asset-based, 21% transaction-based and 31% net interest income-based.

I'll now discuss the significant income and expense component for the fourth quarter in more detail.

Core asset servicing fees for the fourth quarter increased 19% year-over-year and 7% linked quarter due to continued favorable market conditions, wins from new and existing clients, such as Aegon, BGI USA, Eaton Vance, Goldman Sachs and Mass Mutual, as well as our the ability of our clients to develop and sell both new and existing products.

Ancillary services revenue, including cash management foreign exchange and securities lending, increased 30% year-over-year.

Driven by strong increases in FX and cash management fees.

On a linked quarter basis, ancillary services revenue increased 7%, primarily as a result of linked quarter increase in our FX business.

Regarding FX, new clients in higher volatility and volumes in the currencies traded by our clients during the fourth quarter compared to the third quarter caused a 15% linked quarter increase in FX revenue.

FX also increased 82% year-over-year for the same reasons I just mentioned.

Securities lending decreased 27% year-over-year and 4% linked quarter primarily due to narrower spreads.

Net interest income was up 12% on a year-over-year basis, primarily due to balance sheet growth and increased 17% link quarter primarily due to a steeper yield curve and lower prepayments in our mortgage-backed securities portfolio in the fourth quarter as compared to the third quarter.

During the fourth quarter, we employed an asset liability strategy to prepay a high rate FHLP advance and replace it with lower cost term funding.

We continued to maintain strong net interest margin and spread as a result of continued strong client funding.

The linked quarter net interest margin increased by 16 basis points to 1.97%, while the linked quarter interest rate spread grew by 16 basis points to 1.87%.

Absent the prepayment fee of 2 million related to the asset liability strategy mentioned before are linked quarter net interest margin would have increased 26 basis points to 207 while linked quarter interest rate spread would have grown by 26 basis point to 1.97.

Our investment portfolio is compromised of securities backed by the US Government or --and/or AAA rated securities.

We continue to run a closely matched balance sheet with asset duration of approximately 1.6 years and liability duration of approximately a year.

The high amount of variable rate securities in our portfolio has allowed us to continue to maintain low asset duration.

Total operating expenses were up 5% linked quarter compared to our 10% increase in revenue.

Comp and benefits expense was up 2% linked quarter due to higher yet Cap's bonus accruals that were directly tied to our EPS out performance during the quarter.

Transaction processing was up 33% linked quarter due to higher sub custodian fees resulting from higher transaction volumes and asset values.

Our operating philosophy remains the same.

We had incremental expense in new businesses booked.

Given the status of our pipeline the level of the capital markets and the interest rate environment, we have providing diluted earnings per share guidance of $1.86 for the year ended December 31, 2004.

Representing 25% growth over 2003 operating earnings per share of $1.49.

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

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

Thank you. [OPERATOR INSTRUCTIONS].

Up first question from RBC Capital Markets, we'll hear from John Arfstrom.

Good morning, guys.

A question on new business.

Can you talk -- give us a little more detail on Schwab in terms of how large do you think that could be and then more detail on some of the other that you signed up if you could?

I think that the Schwab business is very small piece of their overall business.

It's an (inaudible) for us into that business.

It's probably going to be a 1.5 billion to $2 billion in assets when we convert it in the first quarter.

I think it just goes hand in hand with our philosophy and some of the other clients that - a large clients today where we started with a small piece of business.

Once we get in there, proved ourselves on our performance and our technology and our ability to really do a first-class job, we'll hopefully be able to migrate that into other areas of that particular company.

Okay.

Anything on the others?

In terms of the existing business, John?

I think you mentioned -- I may have misheard you, but you mentioned you signed other -- you had a couple more new clients coming in during the quarters.

Yeah.

We had individually managed accounts in -- you know in the institutional custody business.

In those are a lot of small clients in the advisory business that when you aggregate them all together generate significant assets and -- and revenues going forward.

Okay.

And then I guess another new business question.

In terms of the pipeline, others - you said the sales cycle is still slow.

I'm just curious if you have had any bids that you have lost recently where you felt you couldn't be competitive or I guess, you know, how do we get to medium well, if you will?

Not be smart, but how do you get from medium to medium well in terms of the new business activity?

I think we get there as a result of a more positive environment.

I think most of the investment managers today are not looking how much as survival as starting to make some decisions and implement those decisions.

I think there's been some slowness as a result of the --some of the investigations that have taken place.

Hopefully, those will start to get behind us and the management will be able to start to focus on making some progressive decisions as it relates to their business.

So I think we're seeing more and more bids.

We are seeing more and more opportunities to bid.

The issue is really how many of these are we going to close this year.

I think we're feeling very positive about the upcoming year and the indications that we are getting.

Have you lost any recently or is it just still the slow cycle?

Well, I don't think we have lost any significant pieces of business.

No.

And then I guess the last question on guidance.

You're talking about 186 if you annualize the 48 cents you get to a bit higher than that.

My guess is that maybe there's some head winds in the first quarter.

Can you just talk a little bit about how we should think about the first quarter?

Sure.

I think what we had here were conditions that were favorable on the fourth quarter, which we're able to capitalize on.

The favorable stock market, interest rate environment and our ability to continue to manage expenses.

Our '04 guidance is not based on an improvement in neither the capital markets or the structure of the yield curve.

However we'll need to continue to invest in our business going forward until '04.

You know, typically we don't specifically provide quarterly guidance, but we expect an increase in the first quarter of 2004 operating expenses primarily related to comp, technology and depreciation, which will drive our EPS run rate probably into the mid 40's, 40 cents per share.

So I would say somewhere between 44 and 46 cents in that range.

Okay.

And this assumes no improvement in the shape of the yield curve in the capital markets environment.

I think going back to the success of our business, it is driven by people and technology and as we move into first quarter, compensation expense will increase as a result of paying our people annual raises, filling open positions and then restarting the bonus accrual as the matrix was capped in the fourth quarter.

We'll start accruing bonuses based on the 25% earnings target in first quarter.

Unemployment taxes and FICA come back at you in first quarter.

And then the tech and Telecom side, we have got infrastructure improvements we're making, as well as just continuing to develop our applications in adding more enhancements.

I think finally, depreciation expense will be up year-over-year, primarily as a result of capitalized projects from prior years, it will be put into service in 2004.

Okay.

And then I guess just one follow-up.

Any seasonality in first quarter value added?

I know that second and fourth are generally pretty good, but we expect that to be down a bit in Q1.

No, I don't expect them to be down.

Okay.

You know this is consistent with what we have done historically in terms of our guidance is to go back that 25% long-term growth rate.

As we lock in the performance throughout the year, we improved I mean jack up our guidance and advise you accordingly.

I don't think this year will be any different.

Okay.

Thank you.

You're welcome.

Up next we'll here from Joel Gomberg with William Blair.

Can you go into little more detail on what you're doing for Schwab that's a new business?

Is it just the custody or is there other type of services that you're providing them?

And the overall margins there?

It's custody and fund accounting for in the 401-K trust business for stock pools, and that are created for 401-K plans that have that stock option.

They need to unitize the stock pool we do to custody, the accounting and provide the services back off of services for them in those products.

And as far as margin goes, in terms of all of our business, every single business has to meet a minimum profitability threshold so as so it definitely accords with our margins that we normally get in new business.

And your advisory services fees were up significantly this quarter.

Can you go in a to more detail on that?

Actually, on the linked quarter basis, they were basically flat.

What you have -- if you're comparing numbers that you have for the prior quarter was during this quarter we basically went back for the prior three years and we did a gross up of investment advisory fees for a couple of reasons and I will walk you through that.

Basically, we are the investment adviser to a series of mutual funds called MiraMack (ph) mutual funds.

We get paid advisory fees for that and than we hire sub advisers to sub advise some of those portfolios.

As a result of that, we have a contract with those sub advisers to pay them a fee for that sub advisory work.

Historically, we have been netting that our gross fee against the amount we have paid out to them.

However, the contract between the sub adviser is with us and not with the funds.

So we should probably -- when looked at it, talked to our independent accountants and they agree that we should gross it up because the contractual relationship is between us and not the fund and all you see there is a gross up for this quarter, Joel.

Is there higher expense then as well?

There's no P&L impact.

It is basically a re-class so you gross up advisory fees by I want to say a million 2 this quarter.

And you have in the professional fees line at an million 2 increase of expense.

Net P&L impact is zero.

Obviously, margin gets impacted slightly, but not -- not even noticeable.

And then your average deposits grew 800 million sequentially, is there something -- can you maybe flush that out and what was going on there?

I think a few things are going on.

Clients are starting new products that are driving deposits here.

Still Cap stock is flowing in. and those are the two biggest drivers of balances.

And I think our treasury folks are getting balances from other products that we historically haven't had balances from.

So we continue to penetrate our client base as well.

But Cap stock, what was that?

Cap stock from the funds, so when, you know, when the Blair funds sell shares that Cap stock comes into our firm for period of time before it's actually deployed by the investment manager.

So higher levels of people buying mutual funds in the fourth quarter has provided that cash flow into the products that we service.

That cash stays with us for a period of time until it's deployed.

That's what I mean by Cap stock.

Thanks, John.

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

Good morning.

John, I guess to make sure (inaudible) on the expense side, as you move from the fourth quarter to the first quarter and you look at sequential expenses, it sounds like we're looking at a fairly normal but sequential rise in expenses Q4 to Q1.

Is that the right way to look at it?

That's correct.

And then I guess just maybe a couple of comments from someone of you guys on just competition and pricing, what you're seeing out there, if there are any changes to the environment as we move into this -- hopefully continuing up cycle in the markets?

I think there's always been competition and at the end of the day we still believe it's, you know, service more than price.

And we've seen, you know, very little change in competition in terms of the marketplace.

And then I guess finally to make sure I have the numbers right, I was writing very fast.

In terms of new business wins, you identified the flows that you had gotten from current customers.

Did you specifically break out the flows that you had gotten from new customers and give a total?

Primarily, most of that flow is from existing client, Carla.

The new business from Schwab that Kevin talked about will convert in first quarter.

As I said it's about a billion and a half, to 2 billion.

Okay.

Great, thank you.

[OPERATOR INSTRUCTIONS].

Moving on we'll hear from Tom McCrohan with KBW.

Good morning.

Good morning.

Congratulations, great quarter.

I just wanted to clarify one thing, the Schwab business, I missed the earlier part of the call, was that announced today through the call or maybe I just missed the release that was announced the business a couple weeks ago?

Just today.

It's typically what we do, Tom, is on the quarters we announced new business.

Got you.

And for the sequential growth in the custody asset servicing fees, how much of that growth was due to the Barclays Canada business coming on line?

I don't have that number at my fingertips, but in terms of the total, probably not a big chunk of that because we were up pretty heavily sequentially.

And so you had kind of gone through a breakup but I couldn't write fast enough about the composition of the new revenue growth of this quarter, I think you said 48% was market related.

You kind of go through that composition again for me?

Yeah.

I think it's 48% was asset based, 31 net interest income and 21% transaction based, Tom.

Okay.

Tom, just to follow-up on the Canada question.

We converted that August 1, to our so two of the months of the third quarter we also earned that income.

Okay.

So the dynamics this quarter, trying to get a sense for what drove the acceleration in revenue growth this quarter, which was great to see, but it seems like it was a lot of new business with existing clients.

Is that fair to say?

Existing clients.

Starting new products, existing client, garnering more cap stock into the funds and growing their assets.

And it was market appreciation in trading volumes through the products that our clients manage.

Okay.

One last question.

You had spoke in the past about a pipeline of about eight transactions.

I think in the summer when we had spoken with you.

Those eight transactions still a relevant pipeline?

Yeah.

It's probably one or two more than that, that's a good relevant pipeline in terms of the out sourcing -- the big out sourcing clients we have talked about.

Okay, great.

And given the comments on some of the potential for the mutual fund scandals kind of maybe delaying sales cycle, should we interpret that to say that the revenue growth -- fee income growth that we saw this quarter, the acceleration has some head winds or do you feel comfortable with, you know, the run rate of growth on the income side this quarter running forward?

I think the markets gave us a tremendous amount of lift in the fourth quarter.

And I would say that there would probably be sequentially -- on a percentage basis probably lower in the first quarter.

Great.

Thank you so much.

Great quarter.

Thank you.

Up next, from Millennium Partners, we will hear from Casey Ambrich.

Hi gentleman, thank you very much for taking the call.

Sure Casey.

Great quarter.

Just couple of things.

The recent article (inaudible) suggesting the company was not properly accruing the comp expenses in 3Q '03.

Should we be looking at comp number built on the core business versus the comp number build on a highest pay income?

Say that again, Casey.

Well.

It seems like we were modeling that we kind of build the compensation expense number built on the kind of the core business versus the comp number built on the core business plus the spread income revenue, is that the correct way to look at it can?

It should be built on the total earnings of the firm.

EPS.

EPS.

Okay, great.

That's what I thought.

And then secondly, just as a reminder.

I think, had swaps going to (inaudible) liability got to down to you right?

Yes.

Rising rate environment we should be protected?

Yes.

Yes.

Okay.

And then finally, you mentioned no improvements in capital markets detail.

Was that as of 12-31 or is that just -- or, you know, or since it gained from then?

As of 12-31 going forward.

So our guidance at 12-31 doesn't anticipate upward movements in equity valuations or favorable interest rate environment.

Great.

Thank you very much.

[OPERATOR INSTRUCTIONS].

And we do have a question from Peter McRady (ph) with Principal Capital Management.

Good morning Pete.

Hi, how are you?

Good

Two quick ones.

Do you have a target for balance sheet growth in 2004?

You know, I would say as I said in the past is we're going to generate 25% earnings growth and that earnings will help us in terms of adding capital.

That capital can be deployed to maintain a leverage ratio of 5.5%, and that's really, you know from a modeling perspective if you take that into consideration that should drive your balance sheet growth and ultimately your net interest income growth.

Second question is do you know what head count was at the end of the fourth quarter?

Yeah.

It was 2,413.

Great.

Thanks a lot.

You're welcome, Pete.

And we'll take a followup question from Casey Ambrich with Millennium partners.

Good morning guys.

Jim (inaudible) from Millennium Partners.

Again, great quarter.

I wanted to ask you about the --it's not really guidance, John, but you kind of alluded to what you could earn in Q1 would be, you know, full expectation that you're not going to have much of an implied improvement in capital markets or spread income.

But you did forecast much higher expenses and you still put up I think a number of like 45, 46 cents or 44, 46 cents.

Yeah.

I went back, just now and looked.

You guys have never had a Q4 to Q1 downward earnings.

Yeah.

So I just -- is this conservatism?

Well, I would say that what you had here is an unusual year where we grew our assets 280 billion in the second half of the year, and going into the first quarter we've got a lot of head winds from the equity markets.

And we're having to restart the clock on expenses.

So that's really the reason for the -- for the downward shift, and probably a little bit of conservatism as well.

Okay.

Good.

And then with respect to the spread income outlook what is the ideal -- what is the ideal spread yield curve sort of environment for you guys?

I think the I think the ideal spread is the anticipation of rates going up or rates don't go up.

Great.

So pretty much right where we are right now.

A pretty positive environment.

Excellent and then lastly, is there any impact on you guys from the US dollar weakening?

And if so, what was it in the quarter?

It has a very little impact.

The operation in Dublin is about 4% of our revenue stream, and the way that the revenues are billed versus the expenses being paid, we have a nice hedge against the weaker dollar over in Europe.

And it's 4% of our revenue stream.

So it's not that significant.

Great.

You guys should change your license plates to ISN 50 (ph) because we think that's where it is headed.

Thanks a lot.

You're welcome.

And that does conclude our question and answer session.

A replay of this conference will be available starting at 12:00 noon Eastern Time today.

And will run through January 28 at midnight central time.

To access this replay, you can please dial 719-457-0820, and enter the pass code of 722839.

Again, that is 719-457-0820 with the pass code of 722 -- 722839.

This does conclude today's teleconference.

We'd like to thank you all for your participation.

Thank you.