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Operator
Good day, everyone.
Welcome to the Investors Financial Services Corp. second-quarter 2005 earnings . conference call.
Today's call is being recorded.
At this time for opening remarks and introductions I will turn call over to Mr. Joe DeCristofaro.
Please go ahead.
Joe DeCristofaro - Manager, Investor Relations
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 predictions as of today.
These statements, including but not limited to statements regarding the Company's expected diluted earnings per share, effective tax rate, financial performance relative to competitors, projected net operating revenue, core service fees, ancillary service fees, foreign exchange services fees, net interest income, securities gains, customers conversions and renewals, growth and balance sheet, reinvestment focus, expenses, including compensation, investments in head count and technology, operating margin pipeline, and the impact of an activity under its share repurchase program, are subject to risks and uncertainties .
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 sections of our most recent 10-K and 10-Q filings with the SEC and in a press release filed today on form 8-K.
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 that the statements made today are based on our assumptions as of today, July 14, 2005.
These assumptions may change but the recording of this call will not be updated.
In addition, on this call we will discuss non-GAAP measures as defined by the SEC.
We believe that these measures provide a more useful depiction of the Company's results of operations.
A reconciliation of GAAP information to non-GAAP measures will be discussed in this call and can be found in our form 8-K filed today and located on our web site at www.ibtco.com.
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.
Kevin Sheehan
On today's call, we will cover our revised 2005 and 2006 earnings growth targets and our results for the second quarter of 2005.
During the positive and negative market environments since our IPO in 1995, we've achieved a compound annual growth rate and earnings per share of 39%.
Over the last five years, a period featuring generally weaker financial markets and more regulation of financial products, we have grown earnings per share at a 42% compound annual growth rate.
Clearly impressive accomplishments.
We have also consistently served our customers at the highest levels.
This May we received overall first-place honors in the Global Investor Magazine's 2005 global custody survey and placed first in 17 categories.
In addition to our first place in 2005, we were also ranked best global custodian in 2002 and 2003 and we were ranked second in 2004.
We believe surveys like this validate our commitment to customer service, which represents an important advantage when pursuing new sales.
Turning to new sales environment, we continue to experience higher volumes of IRFP [ph] activity and new product launches by our clients.
As evidence of this positive sales environment for us, we are pleased to announce the signing of a new $30 billion full-service relationship with a major U.S. life insurance company.
We expect to finish this conversion during the third quarter of 2005.
Services for this client include custody, fund accounting, fund administration, and securities lending.
Unfortunately, we have had a strong year for new sales.
We have not been able to sell enough new business to overcome the significant environmental challenges that we are experiencing in 2005.
As both CEO and a stockholder, I am disappointed by the current environment and our revisions to earnings guidance.
We continue to have a strong core business with great opportunities for growth.
As we will discuss in more detail on this call, while the next 18 months will likely present a number of challenges, we believe in the long term we will continue to grow at a level that exceeds industry averages.
In the short term, if we believe market conditions are favorable, we will be a buyer under the repurchase program approved by our board.
During 2005, we've experienced a more challenging environment than we have faced over the previous nine years.
These challenges include a sustained, flatter-than-expected yield curve, narrower-than-expected reinvestment spreads on our reinvestment portfolio, and weaker-than-expected market-sensitive revenues, including those linked to equity and foreign exchange markets and investment advisory fees.
The yield curve and narrower reinvestment spreads have hampered our ability to deploy capital in an effective fashion.
We announced today that the Board of Directors authorized us to buy back up to $150 million of outstanding common stock over the next 12 months.
These conditions are forcing us to revise our expectations for GAAP diluted earnings per share growth for 2005 to approximately 10%, compared to 2004 GAAP diluted EPS of 209.
From a core perspective, we expect 2005 diluted earnings per share to be approximately flat with our 2004 GAAP results of 209 per share.
Core diluted earnings per share for 2005 excludes the impact of securities gains totaling $.10 per share to date in 2005 and approximately $.10 per share related to the recognition of the indefinite reversal provision of APB 23 with respect to the Company's Irish subsidiaries.
Management considers core diluted earnings per share a more useful depiction of the Company's results of Operations as they exclude these noncore items.
We are maintaining a cautiously optimistic outlook for 2006 as we expect to continue to see headwinds driven by a challenging environment for net interest income, flat equity markets, and contract renewals.
We also expect to continue to invest in our infrastructure, which may impact our operating leverage.
For 2006, we expect GAAP diluted earnings per share to be approximately flat with 2005 GAAP diluted earnings per share.
We expect 2006 growth in core diluted earnings per share to be approximately 8% to 10% over expected 2005 core results, reflecting a degree of caution for the reasons I just discussed.
Our new guidance for 2005 and 2006 places an expected financial performance -- our expected financial performance in line with publicly available guidance of our primary competitors.
Long-term, we continue to expect our financial performance to exceed industry averages.
Beyond 2006, we expect long-term growth and diluted EPS of 13% to 15% per year.
As evidence of the continued heath of our business, second-quarter 2005 core service revenues continue to grow at an impressive 14% year-over-year rate.
Ancillary services, such as securities lending, cash management, and sweep fees have also been strong, rising over 120% and 37% respectively compared to the second quarter of 2004.
Our pipeline is still characterized as medium, representing adequate opportunities to meet our revised earnings guidance.
Turning to our second-quarter results, net operating revenue grew 12% year-over-year, driven by increases in core service revenue, cash management, sweep fees, and securities lending fees.
Diluted EPS for the quarter came in at $.64, up 28% from second-quarter 2004 diluted EPS.
As of June 30, we processed approximately 1.5 trillion of assets for our clients, up $27 billion or 2% from March 31, 2005 and up almost 300 billion or 25% from June 30, 2004.
We converted 1 billion from new clients.
We won approximately 14 billion in assets from numerous existing clients during the quarter and we lost 2 billion from a customer related to an acquisition.
Client fund flows and, to a lesser extent, market movements, accounted for approximately 14 billion of the 27 billion increase during the quarter.
Our 1.5 trillion of assets processed does not include approximately 110 billion in assets from our European outsourcing client or the 30 billion in assets from the contract with a major U.S. life insurance company that we announced today.
We expect both of these conversions to be completed during the third quarter.
I'll now turn the call over to John Spinney, who will review the quarter's financial results, as well as our revised 2005-2006 guidance in more detail.
John Spinney, Jr.: As Kevin mentioned, second-quarter diluted EPS came in at $.64, a 28% increase over second-quarter 2004 diluted EPS of $.50.
The $.64 in second-quarter diluted EPS includes securities gains of approximately 5.6 million or approximately $.06 per share related to the Company's strategy of replacing lower after-tax yielding municipal securities with higher after-tax yielding municipal securities, capitalizing on strong market conditions.
We may take a moderate amount of additional securities gains prior to year-end 2005 if we believe we need to realign any aspects of our portfolio.
We do not currently expect to take any securities gains in 2006.
Our second-quarter results also include a one-time benefit of approximately $.10 per share, related to the recognition of the indefinite reversal provision of APB 23, with respect to our Irish subsidiaries.
As a result, the Company's effective tax rate was approximately 23% for the second quarter.
I'll now discuss the significant income and expense components for the second quarter in more detail.
Core service fees for the second quarter increased 14% year-over-year, due to continued wins from new and existing clients as well as slightly higher market values compared to a year ago.
Core service fees were flat linked quarter, primarily due to weaker market conditions in the second-quarter of '05 as compared to the first quarter.
Ancillary services revenue increased 7% year-over-year and 21% linked quarter as a result of increases in cash management sweep fees and securities lending fees.
Regarding FX, we again recorded approximately 12 million in fees in the second quarter of 2005.
These results represent a 15% decline year-over-year and a 7% linked quarter decline.
Similar to the first quarter of 2005, we did not believe that this quarter's total would match last year's second quarter for FX fees, primarily due to lower volumes and volatility in the second quarter of '05 compared to the second quarter of '04.
Sweep fees increased 37% year-over-year to 24% linked quarter, due to increased cash balances held by our clients.
Securities lending fees increased over 120%, both year-over-year at linked quarter due to improved market conditions.
Net interest income was approximately flat on a year-over-year basis as our balance sheet growth was offset by a flatter yield curve.
Net interest income declined 12% linked quarter due to a flatter yield curve and tighter reinvestment spreads.
The linked quarter net interest margin decreased by 28 basis points to 1.47% while the linked quarter interest rate spread decreased by 31 basis points to 1.27% due to the factors I just mentioned.
We continue to invest in the same asset classes we have in the past.
We are focusing our investments on variable rate, short duration securities.
We are not attempting to generate incremental yield by taking on increased risk such as duration and credit risk.
We also continue to run a closely matched balance sheet with an asset duration of approximately 1.1 years and a liability duration of approximately a year.
The high amount of our variable rate securities in our portfolio has allowed us to continue to maintain low asset duration.
Total expenses were up 12% year-over-year and 8% linked quarter.
Comp and benefits expense increased 18% year-over-year due to increased headcount and annual salary increases offset by lower bonus accruals compared to the second-quarter of 2004.
Compensation and benefits expense was up 11% linked quarter due to an increase in headcount as well as bonus accruals reflecting higher net income in the second quarter.
We expect comps and benefits to trend lower in the third and fourth quarters of 2005.
Technology and telecommunications expense grew 25% year-over-year due to our outsourcing agreement with IBM which we entered into in July of 2004.
Technology and telecommunications expense was approximately flat linked quarter.
Transaction processing fees increased 15% year-over-year and 5% linked quarter due to increases in transaction volumes and slightly higher market values.
Occupancy expense declined 10% year-over-year and 6% linked quarter due to favorable lease renegotiations of the majority of our office space.
I would now like to discuss our revised 2005 and 2006 diluted earnings per share guidance.
For fiscal 2005, the Company expects to achieve approximately 10% growth in GAAP diluted earnings per share.
From a core perspective, we expect 2005 diluted earnings per share to be approximately flat with our 2004 GAAP results of $2.09 per share.
As Kevin discussed, core diluted earnings per share for 2005 exclude the impact of securities gains totaling $0.10 per share to date 2005 and approximately $.10 per share related to APB 23.
We expect net operating revenue to grow approximately 10% in 2005.
Core service fees are expected to grow by approximately 15% due to wins through new and existing clients and continued client fund flows, offset by the lackluster performance of the capital markets in the first half of the year.
Total ancillary service fees are expected to increase approximately 5% from 2004 levels with solid growth in both securities and lending, sweep fees, driven by the factors I previously mentioned.
Foreign exchange fees are expected to be approximately flat due to lower volumes and volatility in 2005 compared to 2004.
Net interest income is projected to be down approximately 10% from 188 million in 2004 driven by a flatter-than-expected yield curve environment and tighter-than-expected reinvestment spreads.
We do not expect to grow our balance sheet materially for the remainder of 2005 from its size at the end of the second quarter due to the current interest rate environment.
We will focus on reinvesting portfolio cash flows until the interest rate environment improves.
We assume in our net interest income forecast for 2005 and 2006 that short-term interest rates will rise until the end of 2005, and that the yield curve will remain flat.
We also assume that we will resume growing the balance sheet moderately in 2006 to generate incremental net interest income.
During 2005, total expenses are expected to grow approximately 10%, driven by continued investments in headcount and technology to support new and existing clients.
We expect total second-half 2005 compensation costs to approximate 2005's first-half compensation costs.
We expect to achieve a pretax operating margin for 2005 of between 32 and 34% and an effective tax rate for 2005 of approximately 32% as a result of APB 23.
We recognize the indefinite reversal provision of APB 23 due to the projected capital needs of our subsidiaries necessary to support the continued impressive growth in net income at our Dublin, Ireland operation.
Our Dublin operation has generated revenue growth of at least 40% over each of the past three years, driving markedly higher net income at the subsidiary.
We are maintaining a cautiously optimistic outlook for 2006 as we expect to continue to see headwinds driven by a challenging environment for net interest income, flat equity markets, and contract renewals.
We also expect to continue to invest in our infrastructure, which may impact our operating leverage.
For 2006, we expect GAAP diluted earnings per share to be approximately flat compared to 2005 cap diluted earnings per share.
From a core earnings per share perspective, we are projecting annual growth in 2006 diluted EPS of approximately 8 to 10% over expected 2005 core results.
Again, core 2005 diluted earnings per share excludes the impact of securities gains totaling $.10 per share to date in '05 and $.10 per share related to the recognition of the indefinite reversal provision of APB 23 with respect to our Irish subsidiaries.
We are basing our 2006 earnings guidance on expected net operating revenue growth of approximately 8 to 10% compared to 2005 net operating revenue. 2005 net operating revenue includes approximately 10 million or $0.10 per share in securities gains taken year to date, which we do not expect to recur in 2006.
We expect our 2006 net operating revenue growth to be driven by the sustained strength of our core service business, continued sales of core and ancillary services to new and existing clients, to continued 6% client fund flow, a sustained flat yield curve, and tight reinvestment spreads.
We expect approximately 8 to 10% growth in expenses in 2006 and moderate diluted earnings per share impact from our share repurchase program.
The recognition of the indefinite reversal provision of APB 23 with respect to our Irish subsidiaries should result in an effective tax rate of approximately 34.5% in 2006.
For 2007 and beyond, we are projecting long-term annual growth and net operating revenue of 12 to 14% and annual operating leverage of approximately 50 to 100 basis points, resulting in an annual diluted earnings per share growth of approximately 13 to 15%.
We remain confident in and committed to our business model and our ability to deliver industry-leading customer service levels and financial performance, including long-term earnings growth in excess of industry averages.
Justin, I'd now like to open the call up for questions.
Operator
Thank you. [Operator Instructions] Our first question comes from Jon Arfstrom with RBC Capital Markets.
Jon Arfstrom - Analyst
Hi, guys.
John Spinney, Jr.: Hey, John.
Kevin Sheehan
Hi, John.
Jon Arfstrom - Analyst
Can you just, maybe, John, talk a little bit more about what you are doing or what you're planning on doing with the balance sheet for the second half of the year.
It sounds like, reading between the lines, you are letting cash build, and you will opportunistically trigger the buyback at a certain point in time.
Or do you think that all the cash flow will go to the buyback, or will you let capital build?
Can you just discuss that a little bit?
John Spinney, Jr.: Yes, we're going to pretty much keep the balance sheet at its current levels, reinvest cash flows, and continue to build capital through net income, use some of that capital through net income in our overcapitalization right now, relative to our targeted leverage ratio to buy back stock opportunistically.
Jon Arfstrom - Analyst
Can you remind us the target of leverage ratio?
Does that stay the same?
John Spinney, Jr.: Typically 5 to 5.5, but I think we will be right around 5.5 when we execute the full buyback.
Jon Arfstrom - Analyst
Okay.
And did your guidance include any type of balance sheet restructuring or are you simply letting the cash flows roll in and then deciding what to do with them once they roll in?
John Spinney, Jr.: Yes, there's no restructuring, as I said in the call.
We are investing in the similar type of assets we've always invested in.
Short duration, variable rate products, and we don't see a change in our investment philosophy.
Jon Arfstrom - Analyst
Okay.
Two questions on the '06 guidance.
Does that include options expense?
I don't think that was mentioned in your commentary.
John Spinney, Jr.: Yes, it does.
Jon Arfstrom - Analyst
It does.
Okay.
And then without naming names, I think you said that fee compression from client renegotiations is something you have also imbedded in you're '06 guidance.
Kevin Sheehan
Yes.
John Spinney, Jr.: That's correct.
Jon Arfstrom - Analyst
Okay.
The other question was just on client deposit flows.
It looks like the client deposits are down again sequentially this quarter and I know that that was an issue for a lot of your holders in the last quarter.
Can you talk a little bit about what's happening there?
John Spinney, Jr.: Yes, I think when you look at deposit line, in and of itself it is down.
If you look at the repo line, we're at this other client deposits stats up, and then the sweep balances, the off-balance sheet sweeps, we've had 27% growth in those and 37% growth in those.
So we've got balances growing off balance sheet.
We've got repo balances growing and then some of the deposit flow runoff you see there is just going into clients getting invested again.
Jon Arfstrom - Analyst
Okay.
And then can you -- one last thing, can you just provide a little bit of color on what happened on the second traunch of that European contract?
I think originally your expectation was that it would close late in the second quarter and I am just curious if there was anything unique that happened there?
John Spinney, Jr.: No, we are in complete parallel.
Both sides have signed off on it.
And the next window to implement is mid this quarter.
We both decided that it would be wise to continue in parallel several extra weeks.
Jon Arfstrom - Analyst
Okay.
All right.
I will let others ask questions.
Kevin Sheehan
You're welcome.
Operator
Moving on to Andrea Jao with Lehman Brothers.
Andrea Jao - Analyst
Good evening, gentlemen.
Kevin Sheehan
Hi, Andrea.
Andrea Jao - Analyst
I wanted to drill down a bit on margin compression.
I was hoping you could break that down into -- how much was due to lower reinvestment yields.
How much was due to premium amortization accelerating, if there's any.
And how much of that was, you know, swap ineffectiveness, which added actually the margin, $2.3 million last quarter.
John Spinney, Jr.: I think the biggest driver there is just reinvestment spreads compressing.
The other stuff I would characterize as probably immaterial or similar to what it's been in the past.
Andrea Jao - Analyst
So that means there was no swapping effectiveness this quarter?
John Spinney, Jr.: There was, but it was small in the first quarter.
Andrea Jao - Analyst
Got it.
And just one follow-up question.
Are you carrying a lot of premium bonds at the moment?
John Spinney, Jr.: We have some premium bonds, yes.
Andrea Jao - Analyst
Is it possible to share how much of the mix is premium bonds?
Or is it just a small portion?
John Spinney, Jr.: We typically don't give that amount of detail about our investment portfolio, Andrea.
Andrea Jao - Analyst
Okay.
Got it.
This is helpful.
Thank you.
John Spinney, Jr.: You can see the amortization on the cash flow statement.
Andrea Jao - Analyst
Okay.
Good.
Thanks.
John Spinney, Jr.: Yes.
Operator
This question comes from Lori Applebaum with Goldman Sachs.
Lori Applebaum - Analyst
John, within your revised 2006 expectations, what are your thoughts or assumptions behind the BGI contract repricing and what is factored into the outlook prospecs?
John Spinney, Jr.: We are not going to comment about specific client renegotiations, Lori.
And all I can say is we've got a 8 to 10% revenue growth for next year imbedded in our guidance.
Lori Applebaum - Analyst
And is -- whatever the specific assumptions that you are consider for BGI, is something factored into '06 for summary negotiation of the contract and the price?
John Spinney, Jr.: As we said in the call, we did consider all contracts coming up.
Lori Applebaum - Analyst
Okay.
Thanks.
John Spinney, Jr.: Yes.
Operator
We will take a question from Carla Cooper with Robert W. Baird.
Carla Cooper - Analyst
Good afternoon.
Just to clarify, does your EPS guidance reflect the repurchase activity that you expect to take place or not?
John Spinney, Jr.: In the script, Karla, it's a moderate impact from the buyback.
Carla Cooper - Analyst
Okay.
Thanks.
Wanted to clarify.
And then, can you talk a little bit about -- you know, your expected operating leverage.
You talked about investments in people and infrastructure that you plan to make to support clients.
Is anything changed in the way you are thinking about that -- those expenses, and is there anything specific that you can point to?
John Spinney, Jr.: No, I don't think there is anything specific.
I think it's continued -- addition of headcount related to client conversions and what we have historically done is whenever we take on new business like we announce a new piece of business this quarter, we add headcount ahead of that so we tend to lag a little bit on the expense side.
So that is kind of the investment, and then coupled with that is some technology builds we are doing to enhance some core applications as well.
Carla Cooper - Analyst
And Kevin, I guess back to your comments.
You talked about a pretty dramatic change, vis-a-vis the historical numbers that Investors Financial has achieved.
I guess, how fundamental, as you look from your perch, having been in this business a long time, how fundamental do you view the changes here -- you know, the numbers certainly look like they are changing a lot, but maybe you can give us some perspective of how fundamental these changes feel to you as you look at the next 18 months and beyond.
Kevin Sheehan
I think the big change for us is the compression in the -- in the spreads and our inability to exact any growth in earnings from the net interest income side of the business, at least in this environment where we are facing rising rates.
On the other side, the core side, where we are increasing fee-based services in the ancillaries, I think we are performing pretty strongly and I think we will continue to do that and we will probably drive a lot hotter on that side to compensate for the limitations on the net interest income side and when that becomes more favorable and we can expand that again, you can expect to see us do it.
Carla Cooper - Analyst
So just to clarify, your comments really relate to portfolio yields and net interest income as opposed to a change in the core competitive environment that you think is limiting your growth or your profitability.
Kevin Sheehan
Right.
You can see that's where we got hammered, is on the net interest income side.
Carla Cooper - Analyst
Thank you.
Operator
Moving on to David Chamberlain with PIMCO.
David Chamberlain - Analyst
Hi, Guys.
Just quickly, when you are look at your assumptions for '06, what are you assuming in terms of interest margin, any additional compression from a current level.
What are you thinking on those lines?
John Spinney, Jr.: Our interest rate outlook is a continued rise in short-term rates to the end of the year and probably some continued flattening in the yield curve, depending on what happened to the tenure [ph] but we are assuming it gets flatter from here.
David Chamberlain - Analyst
How much?
Do you think another 20, 25 -- I am just trying to think about how -- what you are assuming.
John Spinney, Jr.: Dave, we don't give point estimates.
We just -- directionally, that is the way it is going to go we think.
David Chamberlain - Analyst
Okay, thanks.
Operator
This question comes from Matt D'Attilio with Reinhart & Mahoney.
Matt D'Attilio - Analyst
Yes, could you guys just comment overall, similar to the previous question on how much compression you think can be left in your business model.
I think part of the surprise on the press release is the 31-basis point contraction, and spread was probably a little bit greater than people's models.
Maybe you can just discuss where it can go from there.
John Spinney, Jr.: It could go down a little bit lower, but we're not going to give an estimate of where we think it's going to end up.
I think, given where the guidance is we have out there and what that means for EPS in the next two quarters, I think it's pretty much baked into the numbers right now.
Matt D'Attilio - Analyst
Okay.
Operator
Mr. D'Attilio, do you have anything further?
Matt D'Attilio - Analyst
No, that's it.
Operator
We'll take a question from Greg Lapin with Saranac Capital.
Greg Lapin - Analyst
Hi.
Greg Lapin at Saranac.
My first question -- just looking at the income statement really quick.
There a typo, or -- you show that the second quarter of '04 having flat net interest income, but when you go back in my model and in the press release it was lower, yet the six-month number is the same.
So I didn't know if there was any reclass or if you could just check on that.
It can't be that way.
So in the past it was $44.3 million, and -- so --
John Spinney, Jr.: Yes, we will go back and look at it, but we did restate some numbers last year, so maybe -- maybe you are looking at your model that maybe wasn't updated.
Greg Lapin - Analyst
But the six-month number is the same in each -- okay.
Then, just going into -- I will follow up.
OCI is reclassed to give transference and net interest income.
Is it safe to assume that this quarter might be the $6.5 million divided by 3?
John Spinney, Jr.: No, it's not safe to do that.
It is a dynamic that changes every quarter and it's less than it was in the first quarter.
Greg Lapin - Analyst
I am not talking about the hedge ineffectiveness -- is that connected with the hedge ineffectiveness?
So that the 6.5 is for the next three quarters?
John Spinney, Jr.: Yes.
Greg Lapin - Analyst
Oh, they are the same thing.
Okay.
Then another thing is just -- if you look at other borrowings, they've -- at the end of period basis, $2 billion, the average was 1.35.
Or the average is 2 billion, the end-of-period is 1.35.
Does this kind of show that you reversed course in the middle of the quarter and decided to change -- and just -- if that is the case, how comprehensive was your business strategy review when you underwent this to reassess your '05, your '06 projections and your long-term growth rates in EPS.
What kind of process was that?
John Spinney, Jr.: First of all, on the borrowings front, the average was higher during the quarter.
At the end of the quarter we had a lot of deposits come in and that's why there's a difference between the average and the quarter-end number.
And we've always historically had some amount of borrowings on our balance sheet to -- to utilize our capital effectively.
Coming out of the first quarter, we had a pretty -- pretty relatively steep yield curve.
We continue to -- to manage net interest income and the growth of the balance sheet around at least getting some benefit out of that steepness.
As the yield curve flattened throughout the second quarter, we reanalyzed our position with respect to growing the balance sheet, and in towards the end of the third quarter, we decided to stop growing the balance sheet into the third and fourth quarter, and that's kind of how it played out, I guess.
Greg Lapin - Analyst
And just for the long term, when you looked in '07 and beyond, we could assume the balance sheet grows, customer flows come in.
Why the lower level to that magnitude?
What else went in -- were you looking at.
Did you have a comprehensive -- do you use consultants, did you look at financial asset growth, you just assess the business?
You are still pretty small.
Just wanted -- anything more you could say on that?
Kevin Sheehan
We just couldn't get the incremental yield so it didn't make sense.
Wasn't effective to continue to grow the balance sheet with borrowed funds.
Greg Lapin - Analyst
The interest rate environment will normalize in '07 so you have a different long-term growth rate, moving down from 25% to 13 to 15.
Kevin Sheehan
Yes, I think you will see us more aggressive, but we wanted to be extremely conservative in putting these numbers together and not reach -- if the rates turn around, great.
We will start to grow the balance sheet again.
Greg Lapin - Analyst
Okay.
Thanks.
Operator
This concludes our question-and-answer session.
A replay of the call will be available starting at 8 p.m.
Eastern time today and will run through July 20 at midnight central time.
To access this replay, please dial 719-457-0820 and enter in the passcode of 5418104.
Again, that is 719-457-0820 with a passcode of 5418104.
At this time, I will turn the call back over to Mr. Kevin Sheehan for closing remarks.
Kevin Sheehan
In closing, thank you for joining us today.
We look forward to updating you on our progress as we get to the third quarter in October.
Operator
Thank you.
That does conclude today's conference call.
Thank you for your participation.