道富銀行 (STT) 2004 Q3 法說會逐字稿

Good day, everyone.

Welcome to the Investors Financial Services Corp.

Third 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.

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 as amended with the SEC.

I recommend 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 the statements made today are based on our assumptions as of today, November 15, 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 will now turn the call over to Kevin Sheehan.

I will begin by reviewing some of the key points from our restatement process which we successfully completed and then turn to our third-quarter results.

John Spinney will finish with the detailed discussion of our financial results.

Senior management, the audit community of the board, our internal auditors and our independent registered public accountants have completed a comprehensive review of the amortization of premiums and accretion of discounts on all of our investment securities.

We have examined the accounting for and evaluation of each and every investment security in our portfolio from December 31, 2000 to September 30, 2004.

We are now amortizing premiums and accreting discounts in the affected securities in accordance with generally accepted accounting principals, including FAS 91.

Again, we're making this statement in relation to all the securities and security types in our portfolio.

Today, we filed an amended annual report on form 10-KA for the year ended December 31, 2003.

Amended quarterly reports on form 10-K -- 10-QA for the first two quarters of 2004 and our quarterly report on form 10-Q for the quarter ended September 30, 2004.

We initially reported on October 21 that the impact of this change was not significant for the years 2002 through 2004, but it resulted in a larger reduction in 2001 reported earnings per share due to the rapidly changing interest rate environment during that period.

The company's cumulative restatement since inception, resulting from the accounting review was a reduction of 6.2 million in net interest income.

The opening adjustment to retained earnings as of January 1, 2001, was an increase of .9 million.

2001's total net interest income adjustment was a reduction of 8.5 million, resulting in a decrease in diluted earning per share of 8 cents.

The net interest income adjustment for 2002 was a reduction of 2.3 million or 2 cents per share.

For 2003, the adjustment was an increase of $1 million or 1 cent per share.

For 2004, the adjustment was an increase of 2.7 million or 2 cents per share.

There was no significant change to our capital or leverage ratios for any restated quarter.

A detailed presentation of the changes arising from the restatement can be found in the reports we filed today with the SEC.

In addition, this restatement did not impact the accounting for our SBA portfolio.

We did, however, correct a clerical error in the contractual maturity table in the MD&A session of our 2003 10-K.

We previously reported federal agency securities having a yield of 3.16% in the over-10-year catagory and 2.76% in the 5- to 10-year category.

These yields should have been 2.71% and 2.28% respectively, consistent with the income we recognize in our financial statements.

To summarize, we undertook a comprehensive effort to audit, recalculate and correct our financial statements and our SEC filings.

We accomplished these tasks in a short period of time thanks to the tireless effort of our dedicated employees.

We will now turn to a review of our financial results.

For the quarter ended September 30, 2004, we reported fully diluted earnings per share of 53 cents, up 29% from the third quarter of 2003's diluted EPS of 41 cents.

For the 9 months ended September 30, 2004, net operating revenue rose 27% to 456 million while diluted operating earnings per share rose 52% and net operating income rose 56%.

Our five-year compound annual growth rate and diluted earnings per share through September 30 remains an impressive 43%.

As we disclosed in our previous call in October, core business trends remain positive.

Our total asset servicing fees for the third quarter grew impressively year-over-year due to three factors: Wins from new clients and existing clients, the ability of our clients to develop and sell product which generates fund flows that have a direct positive impact on our business, and higher asset values compared to a year-ago period.

Also, as previously disclosed, our assets process continued to grow impressively.

As of September 30, we processed approximately 1.2 trillion of assets for our clients, up 40 billion or 3% from June 30, 2004 and up 287 billion or 30% from September 30, 2003.

In addition to the AGON (ph) mandate to perform mutual fund administration for over 100 funds and 30 billion in assets announced on our last call, we're also very pleased to announce we have signed an agreement to provide comprehensive middle office outsourcing services to a new European client.

Under this agreement, we will service approximately 60 billion in assets.

We have also signed a letter of intent with the same new client to provide middle office outsourcing services to another approximately $100 billion in assets for a total of 160 billion in new assets.

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, our third-quarter results demonstrate a continued robust condition of our business.

These results were driven by our ability to sell new and existing clients, strong client fund flows and prudent expense management.

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

As Kevin mentioned, third-quarter diluted EPS came in at 53 cents, a 29% increase over our third-quarter, 2003, diluted EPS of 41 cents.

On a year-over-year basis, our third-quarter net operating revenue increased 22% while our operating expenses grew 15%, again, exhibiting positive earnings growth in the continued leverage of our business model.

For the nine months ended September 30, 2004, net operating revenue rose 27% to 456 million while our expenses grew 14%.

Diluted operating earnings per share rose 52% and net operating income rose 56% for the nine months ended September 30, 2004.

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

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

The breakdown of our revenue stream for the third quarter of 2004 was 52% asset-based, 16% transaction-based, and 32% net interest income based.

I will now discuss the significant income and expense components for the third quarter in more detail.

Core asset servicing fees for the third quarter increased 18% year-over-year due to three factors: Wins from new and existing clients, the ability of our clients to develop and sell product which generates fund flows that have a direct positive impact on our business and higher asset values compared to the year ago period.

The increase in ancillary services revenue is driven primarily by strong increases in cash management and investment advisory fees.

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

The increase in investment advisory fees resulted from higher balances and our proprietary Merrimack money funds.

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% from last year's third quarter to this year's third quarter as a result of strong client funding which, grew 35% year-over-year.

Net interest income was up 31% on a year-over-year basis primarily due to balance sheet growth driven by strong client funding and a relatively steep yield curve.

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

The linked quarter net interest margin increased by 18 basis points to 1.94% while the linked quarter interest rate spread also increased 18 bases points to 1.85%.

Our investment portfolio is comprised of securities backed by the U.S. government and/or triple-A rated securities.

As of September 30, we continue to run a closely-matched balance sheet with an asset duration of approximately 1.4 years and liability duration of approximately one 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 15% year-over-year compared to our 22% increase in net operating revenue.

Compensation and benefits expense was up 6% year-over-year largely due to higher headcount and incentive accruals, partially offset by employee costs that shifted to IBM Global Services as part of our recent outsourcing arrangement.

Technology and telecommunications increased 40% due to increased infrastructure investments and our new outsourcing arrangement with IBM Global Services.

Transaction processing services costs increased 32% due to higher global balances and transactions with our sub-custodians.

Other operating expenses increased 82% to 3.6 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 remain comfortable with our 2004 earnings per share guidance of $2 to $2.05, representing a greater than 35% annual increase in diluted earnings per share.

As we previously stated, our guidance includes a 200 additional 200 basis point increase in the Fed funds rate from today to 4% over the next 15 months.

Included in our guidance is and has always been a forecast of SBAs running at industry prepayment speeds.

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

As we have done historically, we revert back to our historical growth rate of 25% at the outset of a new year and adjust our guidance as we lock in new business.

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

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

If you would like to ask a question, please press the star key followed by the digit 1 on your telephone.

If you're using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment.

We will proceed in the order that you signal us and we'll take as many questions as time permits.

Once again, that's star 1 for your question.

We will pause for just a moment.

The first question is from Jon Arfstrom with RBC Capital Markets.

Good afternoon, guys.

Good afternoon.

Hey, John.

Little different tone on this call than the last one, right?

Yes.

Question on the restatement.

Is it finished, is there any more risk here, is this issue complete and it's over with and we don't have to think about it.

Yes, it's done, Jon.

We made a full assessment and filed everything today.

Any changes you see in your business as a result of this, higher expense rate, does it impede your ability to grow, does it inject volatility, what changes?

It doesn't have any affect on our business whatsoever, especially in terms of continuing to grow the business.

We're still focusing on buying the same types of investments and generating that complementary income from net interest income and we see very little volatility as a result.

Okay.

One of the line-items I think surprised people in late October when you released your numbers was the core fee services line and it was lower than, I think, a lot of people expected.

Can you talk a bit about what caused that and maybe give us an outlook for part way through the fourth quarter since we have seen volumes return in the market, come up a bit.

Sure.

During in the summer time months which, is part of the third quarter, I guess, we're lower volumes across the board on, on all the ancillary services and then within the core business where the buys and sells occur that are part of that “mutual fund fee”.

Those were lower than we had expected and lower than the previous year.

So, as a result, the core revenues were down.

In addition, we have, we've locked up five very significant clients for additional 3- to 5-year contracts and, as a result, had a little bit of fee give-back on some of those clients that flowed through the third quarter, but we expect, with the fourth quarter, with assets up that those asset revenues that came down will be recouped.

I think the other thing that is going to happen in the fourth quarter is it happened a little bit in the third quarter was comp and benefits had some expense related to the business we won, that we talked about on this call and the previous call.

We hire ahead so we're going to have a little bit of expense in the third and the fourth quarter here.

The assets will convert in the end of this year for AGON and then into '05 for the new business that we won in Europe.

So the revenues will catch up with the expenses going into '05 with respect to that.

Okay.

Can you talk a bit about the extent of services that you're providing.

I know you said middle office, but can you describe what you're doing for them.

It's fund accounting, recon, and trade order management.

Custody as well?

Not custody to start with, no.

Okay.

And then I guess the last question is just on your interest rate positioning.

Has anything that the Fed has done so far and the changes in the slope of the curve surprised you or has it all been consistent with your expectations for a flattening curve?

It's pretty consistent with what we expected in terms of what the Fed moves have been.

And it was built into that 300-basis point guidance we gave way back in June and continues to be in our guidance with the 200 basis points up from here today.

All right.

Thanks.

Yes.

We'll now hear from Carla Cooper.

Good afternoon.

Can you just talk a little bit more about what compensation did on a sequential basis.

It looked to me like it was off Q2 to Q3 quite a bit.

Sure, Carla.

Compensation was down on the linked quarter basis, primarily due to lower incentive accruals from the second quarter to the third quarter and just, you know, recalling Q1 and Q2 were significant quarters on the ancillary revenue line-items, as well in the second quarter with the core revenue line items and, as a result, higher incentives are accrued when the revenues and the earnings are there commensurate with those, um, with those expenses.

Thanks and then you said AGON Q4, beginning or end of Q4, and then looking out to next year, um, any, any closer sort of guidance as to when we should look to the revenue from the new clients?

AGON started in the fourth quarter and, um, it will be throughout 2005 that that revenue comes on for the other business.

Great.

Thanks.

Once again, if do you have a question, it's star 1 on your telephone.

If you find that your question has been answered, you may remove yourself by pressing the pound key.

We'll now hear from Casey Ambrich with Millennium Partners.

Good evening, gentlemen, thanks very much for taking the question.

Sure, Casey.

Great quarter, really.

Just a question on the expenses.

Could you just go into this IBM outsourcing agreement and how we should think about that?

Maybe you announced that before, but I don't remember hearing about that.

It was announced before and it's, for the most part, it's expense neutral.

The early part of the contract.

A little bit of overlap that we picked up this year.

For the most part, it has very little impact on expenses going forward.

In fact, I think over time, we'll be able to generate some leverage within that contract to help us.

Okay, great.

Thank you very much.

Yes.

Mr. Sheehan, at this time, I will turn the call back to you.

Thank you, Amy.

In closing, thanks for your patience as we work through this restatement.

Given the new business closing during the month and the increasing demand for our services, we look forward to a strong fiscal 2005.

Thanks again.

That does conclude today's conference.

We thank you for your participation.

You may now disconnect.