道富銀行 (STT) 2005 Q1 法說會逐字稿

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  • Operator

  • Good day everyone, and welcome to the Investors Financial Services Corp. first-quarter 2005 earnings 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 (ph).

  • Please go ahead, sir.

  • Joe DeCristofaro - IR

  • Thank you for joining us on today's call.

  • We will be making a number of forward-looking statements, which will 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-K filing with the SEC.

  • 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 for anyone listening at a later date that the statements made today are based on our assumptions as of today, April 13, 2005.

  • 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 turn the call over to Kevin Sheehan.

  • Kevin Sheehan - Chairman, CEO

  • Thanks, Joe.

  • I will begin by reviewing some of the key points from the first quarter.

  • And then John Spinney will discuss our financial result in more detail.

  • Investors Financial Services recorded solid results for the first quarter of 2005.

  • On a link quarter basis, our net operating revenue grew by 7%, while our operating expenses increased by 2%, again exhibiting positive earnings leverage.

  • Diluted EPS for the quarter came at $0.60, up 15% on a linked quarter basis, and up 11% on a year-over-year basis.

  • We achieved these positive results for the first quarter as well as the final two quarters of 2004 in an environment where the Fed funds rate rose by 175 basis points and the yield curve flatten significantly.

  • As of March 31, we processed approximately 1.47 trillion of assets for our clients, up 39 billion from December 31, 2004, up 338 billion, or 30%, from March 31, 2004.

  • We won approximately $0.5 billion in alternative investment assets from a new client.

  • This is an important win for us because it represents further expansion into the growing alternative asset space, and we are confident this client will create and distribute product which generates fund flows and future revenues for us.

  • We also won custody, fund accounting, and trustee services for the Fidelity Brokerage Company's unitized stock pools, and fund of funds, as well as fund accounting custody and fund administration for Mercer Global Investments' new series of mutual funds.

  • Both are expected to commence in the second quarter of 2005.

  • In addition, we won approximately 7 billion in assets from numerous existing clients during the quarter, including Eaton Vance, Smith Graden (ph), and Vega.

  • As a result of the corporate mergers -- of corporate merger, the ING, ETNA, and the JPMorgan funds we service, representing 9 billion in assets, converted out during the quarter.

  • Market appreciation client fund flows accounted for approximately 40 billion during the quarter.

  • Directly related to the growth of the processing business is the growth of our balance sheet, which on an average basis grew 20% from last year's first quarter to this year (technical difficulty) this balance sheet growth.

  • The current status of our new business pipeline remains medium.

  • We're seeing significant pent-up demand for asset servicing in the investment management industry that was previously subdued due to the regulatory pressures and concerns.

  • As a result, we continue to maintain a positive outlook on our sales pipeline, and believe that sufficient opportunities exist for us to close enough business to meet our financial goals for 2005.

  • Timing of conversion and the close of these sales is key.

  • To summarize, we again delivered solid results for our investors during the first quarter of 2005.

  • These results were driven by positive impact to the business we sold in 2004, strong fund flows, and our continued cost controls.

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

  • John Spinney - CFO

  • Good afternoon.

  • As Kevin mentioned, first-quarter diluted EPS came in at $0.60, an 11% increase over our first-quarter 2004 diluted EPS of $0.54.

  • On a link order basis, diluted EPS rose by $0.08, or 15%.

  • We were able to exhibit positive earnings leverage on both a year-over-year and linked quarter basis.

  • On a linked quarter basis, our net operating revenue grew by 7%, while our operating expenses increased by 2%.

  • 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 first quarter of 2005 was 54% asset based, 16% transaction based, 28% net interest income based, and 2% from securities sales.

  • Our results for the first quarter of 2005, as well as for the second half of 2004, demonstrate this natural hedge.

  • For example, short-term interest rates have increased substantially over the past nine months with a corresponding flattening of the yield curve.

  • We have continued to grow our core asset servicing fees at an impressive rate in this environment.

  • I will now discuss the significant income expense components for the first quarter in more detail.

  • Core asset servicing fees for the first quarter increased 16% year-over-year, and 7% linked quarter, due to previously announced wins from new and existing clients, as well as the ability of our clients to develop and sell product which generates fund flows that have a direct, positive impact on our business.

  • Ancillary services revenue, including cash management, foreign exchange, and securities lending declined 11% year-over-year, primarily driven by a decrease in FX and investment advisory fees.

  • On a link quarter basis, ancillary services revenue increased 6%, primarily as a result of a linked quarter increase in FX and securities lending fees.

  • Regarding FX, we've recorded solid results in the first quarter of 2005 as we generated over 13 million in fees.

  • As we discussed during our last call, we do not believe that this total would match last year's extraordinary first quarter for FX fees, primarily due to lower volatility in the first quarter of '05 compared to the first quarter of '04.

  • However on a link order basis, FX increased 9% due to higher volatility.

  • Sweep fees increased 32% year-over-year, and 9% linked quarter, primarily due to increased domestic and foreign cash balances held by our clients.

  • Securities lending fees increased 76% year-over-year and 37% linked quarter, due to higher balances and improved market conditions.

  • Investment advisory fee revenue declined 51% year-over-year and 36% linked quarter due to lower balances and fee waivers as a result of the rising interest rate environment.

  • Net interest income was down 2% on the year-over-year basis, and 3% linked quarter, primarily due to a flatter yield curve offset by balance sheet growth.

  • The link quarter net interest margin decreased by 13 basis points to 1.75%, while the linked quarter interest rate spread increased by 17 basis points to 1.58%.

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

  • We continue to run a closely matched balance sheet with an asset duration of approximately 1.3 years, and a liability duration of 1.

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

  • We also sold municipal securities during the quarter generating approximately 40 million in gains.

  • We replaced these securities with municipal securities that offer a more attractive after-tax yield.

  • Turning to expenses, again, we were able to grow our revenues faster than the increase in our operating expenses, which were up 5% year-over-year and 2% linked quarter.

  • Compensation and benefits expense increased 3% year-over-year due to increased headcount and annual salary increases.

  • Comp and benefits expense was up 10% linked quarter due to increased salaries related to annual merit increases and additional hiring to support new business.

  • Directly related to compensation were increases in payroll taxes and unemployment insurance.

  • Technology and telecommunications expense grew 24% year-over-year due to our outsourcing agreement with IBM, which we entered into in July of '04.

  • As we discussed in our last call, we planned on our technology and telecommunications expense decreasing on a linked quarter basis, which it did by 14%, due to the elimination of transition costs associated with our outsourcing agreement with IBM.

  • Occupancy expense declined 11% on both a year-over-year and link quarter basis due to favorable new lease agreements negotiated for our Boston office space.

  • Our operating philosophy remains the same.

  • We add incremental expense when new business is booked.

  • Given the status of our pipeline and the level of the capital markets, we are reiterating our 2005 earnings per share guidance of 25% growth.

  • Now, I would like to open up the call to your questions. +++ q-and-a.

  • Operator

  • (OPERATOR INSTRUCTIONS) Jon Arfstrom with RBC Capital Markets.

  • Jon Arfstrom - Analyst

  • A couple of questions for you.

  • Is there any way you can size the new business, the Fidelity and the Mercer business?

  • It sounds like Mercer is pretty small, but can you give us some ballpark idea?

  • John Spinney - CFO

  • Yes.

  • On the Mercer piece, I think on conversion will probably be about 0.5 billion.

  • But I think as a client, as we said earlier in the call, that I think the product is right.

  • They've got a distribution channel.

  • And one of the things that we have really been successful with is aligning ourselves with those types of clients.

  • So I think that we will be able to show positive fund flows on the Fidelity Brokerage Company's business.

  • I think that will start up roughly about 0.5 billion in assets.

  • The total asset pool they have over there in round numbers is about 50 billion.

  • So I think there is -- already defined well that we will get in there, start converting things over, and keep picking away at that asset base like we have on other clients.

  • Jon Arfstrom - Analyst

  • Is that an exclusive -- that Fidelity business or where is in at right now?

  • John Spinney - CFO

  • Right now, as I said, it is for the unitized stock pools and the fund to fund.

  • But I do think that 50 billion is an opportunity we can go after.

  • I don't think we have an exclusive solely on the whole 50 billion.

  • Jon Arfstrom - Analyst

  • Okay.

  • The deposit number for the quarter -- can you talk a little bit about what happened on a sequential basis?

  • I am just curious if there were any deposits attached to the business that went out the door during the quarter.

  • John Spinney - CFO

  • I think that what you see in there is some shift to repo (ph).

  • So repos were up.

  • Deposits were down slightly.

  • And a lot of folks were putting money back into the market, so it was -- typically, that is where the money was running to; it wasn't running outside the door.

  • Jon Arfstrom - Analyst

  • Okay, so the money that came out of deposits most likely ended up in assets under custody?

  • John Spinney - CFO

  • Yes.

  • Jon Arfstrom - Analyst

  • Can you give us an update on the option expense?

  • It sounds like we may have that delayed a bit.

  • Can you give us a little bit of an update on where you are at there?

  • John Spinney - CFO

  • As we said before, we had option expense baked into our earnings guidance this year.

  • And we are analyzing what was in the Wall Street Journal today.

  • If it does get delayed, we will come back and address that, but right now it was in our earnings guidance, Jon.

  • Jon Arfstrom - Analyst

  • And it had been $0.05 or $0.06 cents, is that right?

  • John Spinney - CFO

  • Yes.

  • Jon Arfstrom - Analyst

  • Okay.

  • A couple of more things, the gain, the municipal gain -- anything more we should expect there?

  • It is somewhat unusual for you guys to take a gain.

  • And I understand without it, you were in line with consensus.

  • But can you talk a little bit about the outlook on that?

  • Kevin Sheehan - Chairman, CEO

  • I think, going forward, if we get an opportunity, if we have an opportunity to sell securities, it makes sense for the business and the shareholders we will do that.

  • We don't have any plans today to sell anything.

  • But if an opportunity comes up again, especially in the muni area, we could potentially do that again.

  • Jon Arfstrom - Analyst

  • Okay.

  • And then the last question -- you have another 100 billion coming on at some point in the middle of the year.

  • And I thought I heard you say towards the end of the year that you had built -- some of the expenses that -- for boarding (ph) the first piece of business that has already been set, can you talk about how we should think about that business coming on?

  • When we might see it, and how much expense pressure there would be with boarding that business?

  • John Spinney - CFO

  • I think that will come in the second quarter in terms of the revenue generation, probably towards the end of the second quarter.

  • And there will be some additional expense, but I don't think anything that will change our outlook.

  • Operator

  • Greg Larson (ph) with Sirinach (ph).

  • Greg Larson - Analyst

  • You touched on my question on the -- so there were some conversions and deposits to the repos.

  • How much of the sequential increase represents leverage in that repo balance?

  • John Spinney - CFO

  • The repo balance, pretty much 0.

  • Greg Larson - Analyst

  • Okay.

  • And then just taking the total interest-bearing liabilities, how much is customer driven, and what percentage is leveraged?

  • John Spinney - CFO

  • 100% of the customer deposits on the deposit line -- almost all the repos are client liabilities.

  • And the 8-K where the net interest margin table is laid out, you can see what the short-term borrowings are and other borrowings.

  • That is really where the leverage component is, if that is what you are asking.

  • Operator

  • Joel Gomberg with William Blair.

  • Joel Gomberg - Analyst

  • John, can you talk about your outlook for the rest of the year in terms of the net interest market margin, as the Fed looks like will continue to raise rates, and outlook for net interest income?

  • John Spinney - CFO

  • Yes, our outlook is still the same as it was before, you know, a 4% Fed funds rate by the end of the year.

  • And I think what happened to us, and you saw it in this quarter's results, was probably a little flatter curve than we anticipated.

  • I still think we will probably achieve net interest income about what we achieved last year.

  • We were talking a little bit higher than that before.

  • And depending on how the yield curve behaves the rest of the year, it could be higher than that.

  • So we are just keeping on the steady and trying to manage through it right now.

  • Joel Gomberg - Analyst

  • But net interest income, basically flat year-over-year?

  • John Spinney - CFO

  • It could be flat, year-over-year, Joel.

  • It could be higher than where it is today.

  • Operator

  • Troy Ward, A.G. Edwards.

  • Troy Ward - Analyst

  • My questions were already answered.

  • Thank you.

  • Operator

  • Ryan Rachin (ph), American Express.

  • Ryan Rachin - Analyst

  • Just a question on the security gains.

  • Can you talk a little bit about the impact on the comp line from the security gains?

  • I guess my assumption is that there is probably additional accruals for bonuses, because that is just part of the overall operating profit.

  • Kevin Sheehan - Chairman, CEO

  • I would say that there is no incremental bonus accruals associated with that.

  • Operator

  • (OPERATOR INSTRUCTIONS) Carla Cooper, Robert W. Baird.

  • Carla Cooper - Analyst

  • Could you talk I guess in terms of what your headcount was at the end of the quarter versus last quarter?

  • Did I lose you?

  • John Spinney - CFO

  • Take you off speaker phone.

  • Carla Cooper - Analyst

  • What was your headcount?

  • John Spinney - CFO

  • 2,778 at the end of Q4. 2,812 at the end of Q1.

  • Carla Cooper - Analyst

  • And would you say there are any particular expenses that you are watching and trying to hold back the reins on at this time?

  • John Spinney - CFO

  • I think looking at the numbers, I think we have done a pretty good job of keeping the expenses in check.

  • As we say in the call, and we talk about with you folks all the time is we will add expense when we get more business.

  • We typically added ahead of that, and that is what you saw in the fourth quarter.

  • We announced those two big deals, and that is why the headcount went up in the fourth quarter.

  • And it went up in the first quarter as we closed additional business as well.

  • Carla Cooper - Analyst

  • And what line items do you think we will see go up ahead of the new business that you expect to come on in Q2?

  • John Spinney - CFO

  • It is typically compensation, and sometimes technology.

  • Carla Cooper - Analyst

  • And then I guess the other thing that is out there is the idea that your Barclays contract is up in, I believe it's May of 2006, and the thought that you may enter into discussions with them this year.

  • What do you think the chances are that we see a new contract this year?

  • And in terms of the pricing on that contract, the idea that it might be lower, given how much Barclays has grown, is that factored into your '05 guidance?

  • Kevin Sheehan - Chairman, CEO

  • No, there is no BJ reassessment in our 2005 guidance at all.

  • And you know, I think we have got a great relationship with Barclays.

  • They value that relationship.

  • And we are confident about of a renewal with Barclays in 2006.

  • If anything happens before that, we will be the first to let everybody know.

  • John Spinney - CFO

  • I think it is no different than any other long-term contract, Carla, where we are out ahead of it, and we are talking to them as we would talk to any client.

  • So we are not treating it any differently.

  • Carla Cooper - Analyst

  • And then finally, I guess could you talk a little bit about what you are seeing competitively?

  • And I guess intensity of competition, are there any new basis of competition?

  • John Spinney - CFO

  • Not really.

  • I think it is the same as it always has been, the same players we see in the finals.

  • And just hasn't been any pricing pressure, if that is what you are asking, or any new competitors in this space that weren't there before.

  • Carla Cooper - Analyst

  • All right, one last one.

  • The economics on the alternative assets that you brought on board this quarter, are they different, I guess, in terms -- you know, in absolute, or in the feed that you could expect per -- for the services that you provide?

  • Or do you expect a mix of your fees to be different than your "traditional" business?

  • John Spinney - CFO

  • I would say it is typically a little bit richer margin, because it is more highly technical and requires a different level of skills set.

  • But I would not say it was tremendously higher.

  • Carla Cooper - Analyst

  • And same rough breakdown between transactions, basis point, and net interest income?

  • You know, as you would typically see, or is the overall typically Company average are going to be weighted to different buckets differently?

  • John Spinney - CFO

  • It will probably be similar to what it is for the Company today.

  • Operator

  • Dean Arnold (ph), Millennium Partners.

  • Dean Arnold - Analyst

  • I wanted to -- John, I was wondering if you could shed a little more light on the margin?

  • I know that you had said you have got maybe a higher mix of ARMs today, adjustable-rate securities rather, which might have led to a little bit more of the compression?

  • I think analysts were pretty much modeling -- at least the sell side models I looked at were sort of like the 182 to 183 range for NIM (ph) for quarter.

  • John Spinney - CFO

  • Yes, I think the biggest contributor there was just I think lower reinvestment yields than we expected in our models.

  • And that is really what it amounted to.

  • I don't think that there was anything other than that.

  • Dean Arnold - Analyst

  • Okay.

  • On the movement of customer deposits into some of the repos in those other liabilities, is that seasonal at all, or was it just a matter of clients putting more money to work?

  • John Spinney - CFO

  • You know, I think it was not per se seasonal to the first quarter, but I think it will move with different economic times and different markets, and just how cap stock flows into the funds, and how they manage the portfolio.

  • So it really depends on from quarter to quarter how that moves.

  • And historically, we have seen it ebb and flow quarter to quarter, and it could be different quarters throughout the year.

  • Dean Arnold - Analyst

  • Okay, and then lastly on your comments a few minutes ago about NII being potentially flat and maybe up year-over-year, depending on the yield curve and where rates are -- what does that imply for additional growth or shrinkage in short-term and other borrowings on the balance sheet?

  • John Spinney - CFO

  • You know, I think right now the balance sheet will continue to grow towards the end of the year.

  • And we typically have it forecasted to grow somewhere around 20% as we had year-over-year on the balance sheet right now.

  • And that will come with client liabilities.

  • And to the extent there is a shortfall there, we may use some leverage, we may not, depending on what the investment alternatives are.

  • Dean Arnold - Analyst

  • Okay.

  • Is there a benchmark?

  • When you look at your liabilities, short-term and other borrowings they are about 10%, maybe a little bit more, 12%.

  • Is there a benchmark that you try to keep those to?

  • John Spinney - CFO

  • No, I think as we have talked before, in many instances short-term borrowings are one of those things that can move from day-to-day depending on what type of client liabilities come in.

  • And we have got clients that could come in on any particular day with 0.5 billion or 1 billion of liabilities.

  • And if it happens on a quarter end, and we put up balance sheet out in the quarter end, the client funding will be a lot higher than it is in this quarter end versus any other quarter end.

  • And that is the beauty of running some short-term borrowings is because there is flexibility to buy assets when it is opportunistic for us, and it allows us to manage the liabilities.

  • Operator

  • (OPERATOR INSTRUCTIONS) Emil Stevens (ph) with BAM (ph).

  • Tom Haine - Analyst

  • It is Tom Haine (ph) actually.

  • I apologize.

  • I have kind of lost track here.

  • Is there any business that you have announced in the last couple of quarters that still hasn't been reflected yet, or is it pretty much all in the number that we are seeing here today?

  • John Spinney - CFO

  • The last big piece of business that we announced, that European outsourcing, is still at a little over 100 billion to convert in the second quarter.

  • Tom Haine - Analyst

  • Okay.

  • And then just back to the comp for a second.

  • So it was like -- you said headcount relatively flat from last quarter.

  • The comp expense was up.

  • I mean, could we kind of view that as just conservative accruals as you begin the year, and then you adjust as you go through the year?

  • Or was it really incentive comp that was genuinely earned in the first quarter?

  • John Spinney - CFO

  • Well, it's a few things.

  • It's incentive comp that is genuinely earned against the earnings for the quarter.

  • It is annual focal salary increases, and then the restart on all the unemployment taxes, FICA and 401(k) match.

  • And there was a slight offset from the IBM contract that comp would have been higher in terms of a sequential -- a year-over-year increase.

  • However, with the outsourcing, with the folks that went away with that, that was not in the comp number in the first quarter.

  • It was in the first quarter of 2004.

  • And that's why if you look at the tech and telecom line item, that is up year-over-year.

  • And that is up because it went from comp to services now.

  • Tom Haine - Analyst

  • Okay.

  • And those things you just mentioned -- the kind of beginning of the year type items, are those pretty material that go away in the second quarter, or should we not try and split hairs on those?

  • John Spinney - CFO

  • They are $1 million or two anyway.

  • Operator

  • Stuart Quint (ph) with Gartmore Global Investments (ph).

  • Stuart Quint - Analyst

  • Just a question on your previous comment about net interest -- about the yield curve being flatter than what you had initially anticipated.

  • If you are saying net interest income is flat, and in your guidance -- I am just trying to get a sense for are you implying that there is something else that you are adjusting to offset the expectation that net interest income might be weaker than what you were initially thinking?

  • Or am I reading too much into what you are saying?

  • John Spinney - CFO

  • I think, back to Kevin's comments on his part of the presentation, we see the pipeline as being a lot more robust.

  • And a lot of things are pent-up from the regulatory matters starting to flow through.

  • And clearly closing sales and closing them sooner rather than later is going to make up for that.

  • And with those new sales comes ancillary services, outback securities lending, cash management, that, again, drives some of the higher margin revenue lines items.

  • Stuart Quint - Analyst

  • Okay.

  • I guess just to clarify for me -- so are you saying then -- you are saying that the pipeline is meeting what you said last quarter.

  • Is it that the timing is ticking up since like three months ago, or it's still strong with that basically -- (indiscernible) income is an issue, but it is still not that much of an issue in terms of your guidance?

  • John Spinney - CFO

  • The dollars are in the pipeline, and I think that there are some things that are close to closing in there that we will be able to announce in the next quarter.

  • Operator

  • Jon Arfstrom with RBC Capital Markets.

  • Jon Arfstrom - Analyst

  • I think Stuart got my question.

  • But basically, what you're saying is -- flat to modestly higher NII will be offset by higher-than-expected fee income to get you to 25% growth rate.

  • So the curve is steeper, NII is stronger; curve is flatter, NII is weaker, and the Cs (ph) more than likely will offset any margin pressure that we see.

  • That is what you are saying, right?

  • John Spinney - CFO

  • Yes.

  • Operator

  • And at this time, I would like to turn the call back over to the speakers for any closing or additional remarks.

  • Kevin Sheehan - Chairman, CEO

  • In closing, thank you for your interest in Investors Financial Services.

  • We look forward to updating you on our progress in 2005 this July on our second-quarter earnings conference call.

  • Operator

  • And that does conclude today's teleconference.

  • Once again, we thank you for your participation, and have a wonderful day.