道富銀行 (STT) 2004 Q2 法說會逐字稿

Welcome to the Investors Financial Services Corp. second-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 Joe de Christefaro (ph).

Thanks, operator.

Thank you for joining us on today's call.

We'll be making a number of 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 recommended that anyone listening to this call review these reports carefully.

Because this call will be archived on our website, www.ibtco.com, I want to emphasize again for anyone listening at a later date that the statements made today are based on our assumptions as of today, July 14, 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 Rogers, President, and John Spinney, Chief Financial Officer.

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

Thanks, Joe.

I will begin by reviewing some of the key points from the second quarter and then John Spinney will discuss our financial results in more detail.

Investors Financial Services recorded extremely impressive results for the second quarter of 2004.

Diluted EPS for the quarter came in at 52 cents, up 63 percent from the second quarter of 2003 diluted operating EPS.

Our total asset servicing revenue grew by a strong 30 percent year-over-year, driven by a 27 percent increase in core service revenue and a 39 percent increase in ancillary services fees.

As of June 30, we processed approximately 1.2 trillion of assets for our clients, up 72 billion, or 6 percent, from March 31, 2004, and up 306 billion, or 34 percent, from June 30, 2003.

We converted over 2.4 billion from new clients such as Matlin Patterson in the U.S. and Marathon Asset Management in our Dublin office.

In addition, we grew our institutional custody business by signing several new advisory clients and family offices in the second quarter, including a new $2 billion outsourcing relationship with Manning & Napier, which we expect to convert during the third quarter.

We also won approximately 8.5 billion in assets from numerous existing clients during the quarter, including BGI, Eaton Vance, Goldman Sachs, MassMutual and Vega.

Client fund flows, and to a lesser extent, market appreciation, accounted for approximately 61 billion of the 72 billion increase during the quarter.

Directly related to the growth of our processing business is the growth of our balance sheet, which on an average basis grew 2 billion, or 25 percent, from last year's second quarter to this year's second quarter, as a result of strong client funding.

The current status of our new business pipeline remains medium.

We continue to maintain a positive outlook on our sales pipeline as we are seeing strong levels of RFP activity and increased interest by our clients in our service offerings.

To summarize, we again delivered outstanding results for our investors during the second quarter of 2004.

These results were driven by our ability to sell to new and existing clients, strong client fund flows and a favorable interest rate environment.

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

Good afternoon.

As Kevin mentioned, second quarter diluted EPS came in at 52 cents, a 63 percent increase over our second-quarter 2003 diluted operating EPS of 32 cents, which excludes the 10 cent per share benefit we recognized pursuant to our settlement of a disputed tax matter with the Massachusetts Department of Revenue.

On a year-over-year basis, our second-quarter net operating revenue increased 26 percent, while operating expenses grew 11 percent, again exhibiting positive earnings growth and the continued leverage of our business model.

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

These three revenue components create a natural hedge for our business model.

The breakdown of our revenue stream for the second quarter of 2004 was 52 percent asset-based, 19 percent transaction-based and 29 percent net interest income-based.

I'll now discuss the significant income expense components for the second quarter in more detail.

Core asset servicing fees for the second quarter increased 27 percent year-over-year due to wins from new and existing clients, such as BGI -- including the Canadian outsourcing contract -- Eaton Vance, Goldman Sachs, MassMutual, and Vega; also, the ability of our clients to develop and sell additional product, which generates fund flows that have a direct positive impact on our business, and higher asset levels compared to the year-ago period.

Ancillary service revenue -- including foreign exchange, cash management, securities lending and investment advisory -- increased 39 percent year-over-year.

Each ancillary service exhibited solid year-over-year growth, primarily due to winning new clients and further penetration of existing clients.

FX benefited from new clients, higher volumes and increased volatility in the currency markets.

Cash management suite revenues grew primarily as a result of higher domestic and foreign cash balances held by our clients.

The improvement in securities lending can also be attributed to higher volumes and the international dividend season.

The increase in investment advisory fees resulted from higher balances in our proprietary Merrimac money market funds.

Cash management, securities lending and investment advisory fees were also very strong on a linked-quarter basis, rising 20 percent, 67 percent and 31 percent, respectively.

The reasons for this performance are the same as the ones I just discussed -- new clients and higher balances, and in the case of securities lending, the international dividend season.

Net interest income was up 18 percent on a year-over-year basis, primarily due to balance sheet growth driven by strong client funding and a continued steep yield curve.

During the second quarter, we again employed an asset liability strategy to prepay two higher-rate borrowings and replace them with lower cost to term funding.

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

The linked-quarter net interest margin declined by 16 basis points to 1.85 percent, while the linked-quarter interest rate spread declined by 16 basis points to 1.76 percent.

Absent the prepayment penalties of approximately 4.2 million related to the asset liability strategy, our net interest margin would have been 2.3 percent, while our interest rate spread would have been 1.96 percent.

Our investment portfolio is comprised of securities backed by the U.S. government, or AAA-rated securities.

We continue to run a closely mapped balance sheet with an asset duration of approximately 1.5 years and a liability duration of approximately a year.

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

Total operating expenses were up 11 percent year-over-year compared to our 26 percent increase in net operating revenue.

Compensation and benefits expense was up 6 percent year-over-year, largely due to higher headcount, payroll taxes and incentive accruals.

Depreciation and amortization was up 33 percent year-over-year due to the impact of technology projects being placed in the service in 2004.

In May of 2003, we came off a favorable five year fixed-rate insurance policy.

As a result, insurance expense increased over 100 percent to 1.2 million for the quarter, due to higher premiums.

Operating expenses increased -- other operating expense increased 86 percent to 4.4 million for the quarter, due to increased regulatory assessments due to higher deposit liabilities, higher recruiting expense, increased advertising expense and miscellaneous office expenses.

Given the status of our pipeline, as well as the capital markets and interest rate environments, we are increasing our 2004 earnings per share guidance from $1.90 to $1.95 to $2 to $2.05, representing approximately 35 percent growth over 2003 operating earnings per share of $1.49.

As we have previously stated, our guidance includes a 275 basis point increase in the Fed funds rate from today over the next 18 months.

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

Now I would like to open the call up for your questions.

(OPERATOR INSTRUCTIONS).

Jon Arfstrom, RBC Capital.

A question for you on expenses.

Obviously, expense pressure was something that hit the industry when you crosstown rival reported.

Just curious if you see any expense pressures on the horizon, or is this a good run rate?

No, I don't see any expense pressure on the horizon, John.

This is probably a good run rate for you.

The other question was on FX and just the sustainability versus, call it seasonality, in the business.

And when you go back over the last three years you see higher and higher levels each quarter.

And I'm just curious how this 14 to $15 million quarterly run rate feels, or is there something that we would be missing if we thought that this was a run rate?

It could come off slightly just because the summer is a little slower, but it shouldn't come off that much.

What is going on there?

You talk about new business sales; what -- it's been growing pretty quickly and, obviously, the $18 million number was pretty high.

But what is happening there?

It's continued volumes and volatilities in the currency that (indiscernible) our clients, and clearly the flows have come into the international product that have to be deployed, and the foreign assets need to be exchanged into the local currencies.

And that's where those particular revenues are garnered from in those transactions.

We're constantly calling on our existing clients and new clients to build more and more of a base there.

We, in this quarter, were recognize by Global Investor as the number two FX performance; so that goes a long way to giving credibility to our performance here to our clients.

John, a question on some of the prepayment fees that you pay on the funding side.

It seems to be like this is something that happens every quarter, and I'm just curious if there's a point in time where we'll be done with this and some of the higher margin numbers will be reported.

Or is this something you expect to be ongoing?

I think this will be the last quarter for the near-term future (indiscernible) future here.

We don't have any left.

I was going to ask.

David Chamberlain, (indiscernible) Asset Management.

Just a quick questions.

Can you go over again -- I didn't catch the new business wins versus kind of the inflows from the clients, the numbers of this, the I think it's 67 million -- billion;

I'm sorry.

Out of the 72 billion, there was 2.4 billion from new clients.

There was -- I'm sorry -- 4.4 from new clients and 8.5 from existing clients and 61 billion from market flows and market appreciation of client fund flows.

Okay. 4.4 from new clients, 8.5 from existing, and then 61 is market appreciation?

To a lesser extent, market appreciation mostly fund flows.

Okay.

And just on expense -- just to add on to (indiscernible) question -- on your comp, how much more leverage -- if I look at it just as (indiscernible) of revenues, how much more leverage do you feel you have there on the existing (indiscernible) going forward?

I think we've got some leverage there yet.

Any kind of -- any kind of run rate margins you look at?

We don't comment specifically on line item guidance, but I would say we're guiding up to $2.02 to 2.05 right now from 1.90 to 1.95, and I think you get to kind of bake your assumptions in on the comp.

Carla Cooper, Robert W. Baird.

I had a question, I guess also about your guidance.

Just if I think about your new guidance, even the top end of the range implies that the quarters coming up in the back half of the year are going to be a little weaker than certainly what we saw this quarter.

And I'm just wondering sort of philosophically, what sort of lens -- is there anything sort of conservatism baked in there, or what kind of -- I don't think you've ever had a year where the quarters have sort of been flat.

I think on the guidance front, Carla, we brought it up to a point where we felt comfortable achieving those numbers.

And giving ourselves some flexibility, as we've historically always done, we start with a 25 percent growth rate at the beginning of the year and try to outperform it quarter after quarter and try to guide you up, and try not to get ahead of ourselves.

Fair enough.

And then, in Q2 can you talk about anything that would be -- or even remind us of the strategy that the Company employs for accruing for bonuses, and how that might have impacted the comp number?

The second quarter accrual was a little bit lower than the first quarter accrual, and we'll continue to accrue bonus into the third and fourth quarter to round out the year, but probably at lesser amounts.

Is that because you run into that cap that exists on bonuses?

That's correct.

Jamie Lester (ph) SAB Capital Management.

Great quarter.

First question was on the occupancy expense.

What caused the drop quarter-over-quarter in that?

Pretty simple; we had favorable valuations on the buildings in Boston and got real estate tax relief, and a final true-up of our operating escalations from the landlords (multiple speakers)

That's the go-forward run rate on that?

It's probably a little higher than that, because there was some pickup related to the whole year.

So it's a little bit higher than what it is today.

Fair enough.

And then on the leverage side, the equity was down quarter-over-quarter, I assume because we're marked to market on some of the assets.

The marked to market is 25 million negative at the end of the quarter, which is really minor in our opinion and doesn't affect our regulatory capital.

I'm with you;

I'm just trying to see -- you guys, obviously, had net income of what, 35 million?

But equity was down 10 million in the quarter.

So, I guess, what happened there?

We had net income and then we had the marked to market on the portfolio, and the offset for the marked to market in the swaps runs through other OCI.

So there's another 20 million of swap?

Roughly about 20 million; yes.

And then, where do you see, or how do you stand on the leverage side now?

It looks like ending assets (indiscernible) interest-bearing assets of (indiscernible) I guess you look at total assets.

I guess just walk us through where you are on the leverage side; it seems like you're kind of getting -- creeping towards the top-end.

We're at like the 5 58 (ph), I think, at the end of the quarter.

And I think we will trend a little bit higher towards the end of the year; so that's still under 6 percent.

It looks like, if you look at a spread, non-interest income to non-interest expense, it seems to be kind of trending up.

Should we look at that growth rate -- whatever it is, 5 million a quarter, plus or minus -- as continuing through the year?

How do you think about that, or is that even a useful metric to look at?

I don't necessarily use that metric per se, but I think you could probably intuitively say that would go up.

What was the -- you mentioned the adjusted spread.

If you take out the prepay penalties on the liability side for the quarter, what were the --?

The margin would have been 203 and the spread would have been 196.

What would the spread have been for the first quarter on that same basis?

I don't have that handy; it's probably about 10 basis points higher (multiple speakers) 13 and 206, probably.

So you did see some compression in the quarter?

Slightly.

Fulcrum Global Partners, Tom McCrohan.

You answered most of my questions, and maybe you answered this one as well, but just to clarify.

Did the staff-related comp and benefits go down sequentially?

No, they did not go down sequentially.

The thing that came down was the taxes that we talked about in the first quarter, because they pretty much had all accrued up earlier in the year.

So that's the biggest component of that number, of the sequentially down number.

And the other piece that drove that down was capitalized software was about a half-million higher in the second quarter.

Joel Gomberg, William Blair.

The 61 billion -- that wasn't market appreciation, obviously.

Could you just flush that out in terms of the assets (indiscernible) and what product sets are driving that?

I would say first of all the markets were up probably less than 1 percent on an average daily linked basis.

So starting with our 1.1 trillion from the last quarter, you're talking about 11 billion.

So 50 billion of it was coming from new clients.

We saw strong flows on the ETF products, and we saw strong flows across the big clients that Kevin mentioned on the new revenue front as well, Joel.

We continue to see good growth out of Dublin as well.

Could you expand a little bit, as you look out the next couple of years, your attitude on acquisitions, new areas or new locations?

You know, I think we're always looking for an acquisition that is close or related to the businesses we are in.

But we have strict guidelines that ensure that it is accretive within the first year.

And we don't find a lot of opportunities there, but we have found several over time.

I think we are also strategically looking to see, using our Dublin operation as a hub, are there other locations in Europe that we can have administrative an office and leverage our opportunities in Europe as well?

Ladies and gentlemen, that will conclude today's question and answer session.

A reminder that a replay of this call will be available starting at 8 PM Eastern time today and will run through midnight on July 20.

To access this replay please dial area code 719-457-0820 and enter the passcode of 457951. (OPERATOR INSTRUCTIONS).

Again, thank you all very much for your participation.

That conclude today's conference call.