道富銀行 (STT) 2006 Q1 法說會逐字稿

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  • Operator

  • Good day, everyone, and welcome to the Investors Financial Services Corporation first quarter 2006 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 Ms. Ann [Bourke], Senior Director of Investor Relations taking over the IR role from Joe Decristofaro.

  • Please go ahead.

  • Ann Bourke - Senior Director IR

  • Good evening, everyone.

  • 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, interest rates, projected shape of yield curve, projected net operating revenue, core service fees, value-added service fees, foreign exchange service fees, net interest income, securities gains, new customers, RFP activity and customer product launches, client renewals, client balance sheet growth, reinvestment focus, expenses including compensation, technology and office space, operating margins, pipeline, and the impact of and 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 the Form 8-K we filed today, which includes our press release.

  • 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, April 12, 2006.

  • 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.

  • Kevin Sheehan - Chairman and CEO

  • Thanks.

  • I want to begin by announcing that we've extended our iShares and master investment portfolio custody and fund accounting contracts with BGI.

  • These renewals are on substantially identical terms to the renewal of the BGI U.S.

  • Asset Administration outsourcing agreement that we announced on last quarter's conference call.

  • A seven-year term with a mutual right to renegotiate pricing of the agreements at 3.5 years.

  • In addition, earlier this year we broadened our capabilities in Europe with the opening of new offices in London and Luxembourg to support our clients' expansion plans and capitalize on significant opportunities in these markets.

  • Now, let me turn to the key points from the first quarter and then John Spinney will discuss our financial results in more detail.

  • Net operating revenue grew 15% year-over-year, driven by core service fee growth of 22% and value-added service fee growth of 52%.

  • Notable gains in securities lending, foreign exchange and cash management sweep fees drove this value-added fee growth.

  • Total operating expenses were up 29% year-over-year for the first quarter.

  • For the full year, expenses are now expected to increase 16% to 19% compared to 2005.

  • As a result of investments to position the Company for future growth such as additional management, technology and office space.

  • These stepped variable costs are warranted investments, as we continue to expand and enhance our products and services in several high growth securities processing areas.

  • Diluted EPS for the quarter came in at $0.56, compared to $0.60 in the first quarter of 2005.

  • As of March 31, we processed approximately 1.9 trillion of assets for our clients, up 8% from December 31, 2005, and up 31% from March 31, 2005.

  • Client fund flows and market movements accounted for most of the increases in assets processed during the quarter.

  • Turning to the sales environment.

  • We continued to experience solid RFP activity and new product launches by our clients.

  • Our pipeline continues to be characterized as medium, representing adequate opportunities to meet our earnings per share growth guidance.

  • I will now turn the call over to John Spinney, who will review the quarter's financial results as well as our expectations for this year in more detail.

  • John Spinney - CFO, PAO and SVP

  • Good afternoon.

  • As Kevin mentioned, first quarter diluted EPS came in at $0.56, compared to $0.60 in the first quarter of 2005.

  • First quarter 2005 diluted EPS includes securities gains of $0.04 per diluted share.

  • Net operating revenue for the first quarter increased 15% year-over-year due to new business wins, higher client asset values and value-added service fees.

  • Net operating revenue for the first quarter increased 2% linked quarter due to higher core service fees and strong security lending fees.

  • Core service fees for the first quarter increased 22% year-over-year due to wins from new and existing clients as well as higher client asset values.

  • Core service fees increased 6% linked quarter, due to new client funds, higher client fund flows and increased market values.

  • Value-added service fee revenue increased 52% year-over-year, as a result of strong increases in securities lending, foreign exchange and cash management sweep fees.

  • Value-added service fees decreased 1% linked quarter due to lower sweep fees and FX fees.

  • Securities lending fees increased 68% year-over-year and 15% linked quarter, due to new business and favorable market conditions.

  • Regarding FX, we recorded approximately 20 million in fees in the first quarter of 2006.

  • These results represent a 54% year-over-year increase due to new business, increased client volumes and continued FX volatility.

  • FX decreased 3% linked quarter due to slightly lower volumes and market volatility.

  • Although we expect some growth in FX fees for 2006, we do not expect them to remain this high on a quarterly basis in 2006.

  • Sweep fees increased 53% year-over-year, due to new business and higher client balances, and decreased 3% linked quarter due to slightly lower client balances.

  • Net interest income was down 9% on a year-over-year basis.

  • As our balance sheet growth was offset by a flatter yield curve and tighter reinvestment spreads.

  • Net interest income was up 1% on a linked quarter basis.

  • The linked quarter net interest margin increased 3 basis points to 1.51%, while the linked quarter interest rate spread increased 1 basis point to 1.23%.

  • 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.

  • And 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 1.3 years and a liability duration of approximately one year.

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

  • Total operating expenses were up 29% year-over-year and 8% linked quarter, due to investments to position the Company for future growth such as additional management, technology and office space.

  • These stepped variable costs are warranted investments, as we continue to expand and enhance our products and services with several high growth securities processing areas.

  • Now, I will detail the significant expenses separately.

  • Compensation and benefits expense increased 35% year-over-year and 19% linked quarter, due to increased personnel for our Boston and European offices, which included additional management.

  • Annual salary increases, bonus accruals and option expenses also contributed to the growth in the compensation and benefits expense.

  • Technology and telecommunications expense increased 35% year-over-year and 17% linked quarter, reflecting our commitment to our global integrated technology platform, which we view as a significant competitive advantage.

  • Transaction processing fees increased 23% year-over-year due to increases in transaction volumes and higher market values.

  • Transaction processing fees decreased 6% linked quarter.

  • Occupancy expense increased 15% year-over-year and 7% linked quarter, due to new office space in Boston, London and Luxembourg.

  • Now, turning to our guidance, our outlook for 2006 diluted earnings per share remains unchanged.

  • However, we are modifying our 2006 net operating revenue to total operating expense guidance.

  • We now expect our 2006 net operating revenue to grow approximately 11% to 14% compared to 2005 net operating revenue.

  • We expect revenue growth to be driven by the sustained strength of our core services business, continued sales of core and value-added services to new and existing clients, historically comparable client fund flows, a sustained flat yield curve and tight reinvestment spreads.

  • As Kevin mentioned, we are now forecasting approximately 16% to 19% growth in total operating expenses, as a result of continued investments in our infrastructure, which will position the Company for future growth including additional management technology and office space for both our U.S. and European operations.

  • As we've said before, we believe the long-term success of the Company is based on quality customer service and our integrated technology platform.

  • We are willing to forego some operating leverage in the short-term to invest for future growth in the long-term.

  • We are still projecting 2006 diluted EPS of approximately $2.32 to $2.37 per share.

  • This guidance assumes the Federal Reserve will continue to raise short-term rates through the second quarter of 2006 and the yield curve will remain very flat without a sustained inversion in 2006.

  • We expect our effective tax rate to be approximately 34.5%.

  • We still plan to keep our balance sheet relatively flat until the interest rate environment improves.

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

  • Operator

  • [OPERATOR INSTRUCTIONS] Our first question is from John Arfstrom of RBC Capital Markets.

  • John Afrstrom - Analyst

  • Good afternoon, guys.

  • Nice job.

  • Kevin, can you just talk a little about the initial Barclays renewal, is that January 1 similar to the agreement that you had signed the last quarter?

  • Or is this something that will phase in in April?

  • Kevin Sheehan - Chairman and CEO

  • I believe the effective date is March, isn't it?

  • John Spinney - CFO, PAO and SVP

  • Most of it is effective January 1, John.

  • John Afrstrom - Analyst

  • Most.

  • So, we're basically -- we've seen the extent of the Barclay's repricing pressure?

  • Kevin Sheehan - Chairman and CEO

  • Most of it.

  • John Afrstrom - Analyst

  • That's good.

  • John, does it feel like -- your margin performance, I think, has been strong compared to some of the expectations that people had over the last two quarters.

  • In this type of environment does it feel like 150 is a manageable margin?

  • John Spinney - CFO, PAO and SVP

  • I will say I am happy with the 150 right now, John, but I can't predict whether it is going to be up or down.

  • As we said, we're not going to predict that.

  • I think if balances stay strong, or we continue to get more client balances, that will help margin going forward.

  • And it is just what happens with the yield curve really.

  • John Afrstrom - Analyst

  • Okay.

  • Can you guys talk a little bit about client funds that you've kept off the balance sheet and what's happened to those balances maybe over the last nine to twelve months since you've decided not to grow your balance sheet aggressively?

  • Has that increased and is there any way you can size that for us?

  • Kevin Sheehan - Chairman and CEO

  • Those balances have increased and that kind of manifests itself in the sweep fee line, John.

  • And we typically don't give out the balances that are off balance sheet.

  • But the whole business itself generates approximately 30 or so billion of cash on a daily basis.

  • John Afrstrom - Analyst

  • Okay.

  • And then the other question is on expenses.

  • That was the one surprise and I know you guys warned last quarter, but these numbers are a little higher than I think people had expected.

  • Can you talk about the balance between the step function and expenses that you referred to in your comments and how much more of this we might see in coming quarters?

  • Or have we seen the bulk of the build in the first quarter?

  • Kevin Sheehan - Chairman and CEO

  • I think you have probably seen the bulk of it in the first quarter.

  • And I don't expect it to have this much of an impact going forward in terms of the growth on a linked quarter basis.

  • John Afrstrom - Analyst

  • All right.

  • Thank you.

  • Kevin Sheehan - Chairman and CEO

  • You're welcome.

  • Operator

  • We'll now move on to Andrea Jao of Lehman Brothers.

  • Andrea Jao - Analyst

  • Good afternoon.

  • While your EPS guidance has not changed, your previous guidance in operating revenue was for 10% and for expense growth 10% to 12%.

  • So, comparing that to your current guidance, it looks like you're forecasting a little better operating leverage.

  • Could you talk a bit more about what lies behind that and what the major drivers would be?

  • Kevin Sheehan - Chairman and CEO

  • I would probably say that there is more higher margin revenues attributable to that revenue growth than previously anticipated, Andrea.

  • Andrea Jao - Analyst

  • Any particular product lines or geographies that you could -- you're willing to share with us?

  • Kevin Sheehan - Chairman and CEO

  • I think across the ancillary line items in particular, and if we continue to see the flows into our client products and market value movements some, that's clearly pure margin type of revenues.

  • Andrea Jao - Analyst

  • Perfect.

  • Thank you.

  • Operator

  • Moving on we'll hear from Brian Bedell of Merrill Lynch.

  • Brian Bedell - Analyst

  • Hi, guys, could you just talk a little about the -- on the core service fee line, based on your fund flows and the market appreciation, it looks like the Barclays repricing really didn't have a huge impact.

  • Is that correct?

  • Kevin Sheehan - Chairman and CEO

  • We're not talking specifically about Barclay’s.

  • But clearly the revenue growth continues to be strong and we weathered that renewal exactly as we expected.

  • Brian Bedell - Analyst

  • Right, right.

  • But if you didn't have the renewal, you would have probably significantly higher core service fees?

  • Kevin Sheehan - Chairman and CEO

  • We would have a different number most likely but I am not going to tell you exactly what the number is.

  • Brian Bedell - Analyst

  • Okay.

  • All right.

  • Sure.

  • And is Barclay’s Canada also in this contract renewal?

  • Kevin Sheehan - Chairman and CEO

  • It wasn't.

  • Brian Bedell - Analyst

  • That comes up later, then, I guess, right?

  • Next year?

  • Kevin Sheehan - Chairman and CEO

  • It comes up later.

  • It is less significant.

  • Brian Bedell - Analyst

  • Right.

  • And so the fund flows, would you be able to break out the market appreciation versus the fund flows in 1Q?

  • John Spinney - CFO, PAO and SVP

  • No, we typically don't.

  • Brian Bedell - Analyst

  • Okay.

  • And for -- could you talk about the sustainability of the deposit trend on the liability side of the balance sheet?

  • To what degree are you guys comfortable that you'll be able to continue to generate lower costs of positives relative to your repo funding?

  • Or is this the trend that is sort of -- is erratic from quarter to quarter and kind of unpredictable?

  • John Spinney - CFO, PAO and SVP

  • Well, the first thing I'll say is the repo funding is primarily client based and the deposits are solely client based as well.

  • And we've seen good deposit growth over the last six to nine months.

  • And given the growth in assets processed, I would expect to see solid balances and hopefully continued growth in that area going forward.

  • Brian Bedell - Analyst

  • And it is pretty well linked to your growth in overall assets service?

  • John Spinney - CFO, PAO and SVP

  • There’s a correlation, definitely.

  • Brian Bedell - Analyst

  • So, going back to serviced assets, you said you had a good pipeline and good RFP productivity.

  • But are you -- or did you convert any new business in 1Q or are you planning to convert any major new business in upcoming quarters?

  • Kevin Sheehan - Chairman and CEO

  • During the first quarter we saw a lot of new funds from existing clients, and a lot of new product from new clients, that is real de novo type product that we think is going to have a tremendous opportunity to grow in scale and really generate good top line growth for us in ancillary service revenues.

  • So,- although the number we came out with today may have looked as if there wasn't a lot of new business, there was a tremendous amount of new business booked in the first quarter in terms of number of funds.

  • It is just that the asset values are lower than bringing in a brand new $30 billion conversion from a competitor.

  • Brian Bedell - Analyst

  • Right.

  • I see.

  • It is embedded in the fund flows number, the market/fund flows number essentially.

  • Kevin Sheehan - Chairman and CEO

  • For the most part.

  • Brian Bedell - Analyst

  • And would you want to share with us at all what type of products we're talking about?

  • Are they mutual fund products or managed account products?

  • Kevin Sheehan - Chairman and CEO

  • Across the board mutual funds, loan funds, middle office services, hedge funds.

  • John Spinney - CFO, PAO and SVP

  • Private equity.

  • Brian Bedell - Analyst

  • Private equity.

  • Okay.

  • And then just in the comp expense increase in 1Q, what portion of that was due to options expense?

  • Kevin Sheehan - Chairman and CEO

  • About $1 million.

  • Brian Bedell - Analyst

  • And your outlook is still for, I think you said, $0.05 impact from options expense in '06 versus '05?

  • Kevin Sheehan - Chairman and CEO

  • That's correct.

  • Brian Bedell - Analyst

  • Okay.

  • Great.

  • Thank you very much.

  • Kevin Sheehan - Chairman and CEO

  • You're welcome, Brian.

  • Operator

  • Robert Rutschow of Prudential Equity has our next question.

  • Robert Rutschow - Analyst

  • I just wanted to be clear, the Barclay’s contract, you don't expect any additional pressure from that in future quarters [of] repricing?

  • Kevin Sheehan - Chairman and CEO

  • That's correct.

  • Robert Rutschow - Analyst

  • And you mentioned that the foreign exchange that you expected, you don't expect it to stay at the current levels.

  • I am wondering why you think that is, if there is any specific type of activity you think is temporary?

  • Kevin Sheehan - Chairman and CEO

  • I just think that, 20 million a quarter would be an 80 million run rate coming off mid 60's last year.

  • And could it happen?

  • Yes, but you have the summer months coming up after the second quarter.

  • If the second quarter stays active we may get a decent second quarter relative to first.

  • Summer months typically are slower, although I have been wrong on that in the past.

  • So, I think we want to set appropriate expectations that it is going to grow, but it may not achieve four times 20.

  • Robert Rutschow - Analyst

  • Okay.

  • And in terms of the yields you got, it looked like the yield on loans is up about 110 basis points linked quarter.

  • I was just wondering why that was?

  • Kevin Sheehan - Chairman and CEO

  • There were more loans at higher pricing and also higher levels of overdrafts during the period.

  • Robert Rutschow - Analyst

  • Okay.

  • And it seems like you have been able to pass along a little bit less of the Fed funds increase on your repos.

  • What's going on there?

  • John Spinney - CFO, PAO and SVP

  • I think it is probably a little bit more of a mix than it is a pricing.

  • Robert Rutschow - Analyst

  • So more client activity or --?

  • John Spinney - CFO, PAO and SVP

  • Potentially more client activity versus overnight repo with the Street.

  • Robert Rutschow - Analyst

  • Okay.

  • And then lastly, just if I could delve into the salaries and benefits line a little bit more.

  • You said 1 million in options expense.

  • Are you accruing bonuses at the same pace that you had last year or --?

  • John Spinney - CFO, PAO and SVP

  • We're accruing the bonuses commensurate with our EPS target of $2.32 to $2.37, yes.

  • Robert Rutschow - Analyst

  • So, was there a big increase in head count this quarter?

  • John Spinney - CFO, PAO and SVP

  • Sequentially head count was up from 3,250 to 3,460.

  • So, a couple hundred heads sequentially.

  • Robert Rutschow - Analyst

  • And that would account for most of the increase?

  • John Spinney - CFO, PAO and SVP

  • Well, the biggest thing that drove comps, going back to what I said, was increase in head count, A. Second thing is your annual salary increases.

  • Third thing was the option expense.

  • The fourth thing is all the restarts on all your taxes, 401(K) match and all of those things.

  • But the two biggest drivers are probably head count, annual increases and bonus accruals.

  • Robert Rutschow - Analyst

  • Okay.

  • Thank you.

  • Kevin Sheehan - Chairman and CEO

  • You're welcome, Rob.

  • Operator

  • Now from Goldman Sachs we have Lori Appelbaum.

  • Lori Appelbaum - Analyst

  • John and Kevin, to your opening comments on where you're investing and some of the follow-up questions, if you could be more specific about where these more sizable value-added opportunities are that you're spending on at the moment?

  • Kevin Sheehan - Chairman and CEO

  • I think it is in the U.S. in all the products that we service here.

  • And in particular, we're seeing hedge funds here and in Europe growing.

  • We're getting big opportunities both here and in Europe to bid on business.

  • And as a result of that, we're making investments in additional management expertise, adding additional technology.

  • And you can see by the head count growth, we need additional space as we're coming down to being out of space.

  • So, we're starting to build up that stepped variable cost that's going to come on.

  • And we're going to take more space and we'll probably take more management expertise.

  • But our estimation is we will grow into that.

  • Lori Appelbaum - Analyst

  • So, in the U.S. it is mostly hedge fund capabilities.

  • And in Europe it is building out a platform off of what you already have in Ireland?

  • Kevin Sheehan - Chairman and CEO

  • It is the same -- it is that, and it is the same type of opportunities there, of hedge funds and different types of investment structures.

  • And in the U.S. it is middle office as well.

  • Lori Appelbaum - Analyst

  • And how big is Europe to the revenue base right now?

  • Kevin Sheehan - Chairman and CEO

  • Dublin operation is like 6%.

  • Lori Appelbaum - Analyst

  • 6%.

  • And how fast has that been growing?

  • Kevin Sheehan - Chairman and CEO

  • 40%, 50% a year.

  • Lori Appelbaum - Analyst

  • Okay.

  • Thank you.

  • Operator

  • [OPERATOR INSTRUCTIONS] We'll now take a follow-up questions from Andrea Jao of Lehman Brothers.

  • Andrea Jao - Analyst

  • Hoping you could give us a little more detail on client versus institutional funding on the borrowing side?

  • Just wanted to get an idea of how much remains in your repo book and other borrowings that are non-client related?

  • John Spinney - CFO, PAO and SVP

  • The way I’d characterize the funding of the balance sheet is a majority of the funding on the balance sheet is client driven when you look at deposits and repos. (Indiscernible) All the deposits are -- and the repos, I would say a majority of those repo balances are with clients.

  • The big piece that you're thinking about is the short-term and other borrowings and that's purely borrowed funds.

  • Andrea Jao - Analyst

  • Okay.

  • Good to know.

  • In your previous guidance you also mentioned that share repurchases would have very little impact in '06.

  • Is that still the case?

  • John Spinney - CFO, PAO and SVP

  • Well, based on the fact that we didn't do any repurchases in the first quarter, right now it is not having much of an impact.

  • But we do have a carry-over benefit from last year that's baked into the guidance already.

  • Andrea Jao - Analyst

  • And no plans for the remainder of the year?

  • John Spinney - CFO, PAO and SVP

  • We find --

  • Andrea Jao - Analyst

  • For additional.

  • John Spinney - CFO, PAO and SVP

  • If we see an opportunity we may be in the market.

  • But we haven't so far.

  • Andrea Jao - Analyst

  • Okay.

  • Perfect.

  • Thank you.

  • John Spinney - CFO, PAO and SVP

  • You're welcome.

  • Operator

  • And this concludes our question and answer session.

  • A replay of this call will be available starting at 8:00 p.m.

  • Eastern Time today and will run through April 18 at midnight Central Time.

  • To access this replay please dial 719-457-0820 and enter in the pass code 6393482.

  • That's 719-457-0820 with a pass code of 6393482.

  • At this time, I would like the turn the call back over to Mr. Kevin Sheehan for closing remarks.

  • Kevin Sheehan - Chairman and CEO

  • That concludes our call.

  • Thank you for joining us today.

  • And we will look forward to updating you on our progress in July at our second quarter earnings conference call.

  • Operator

  • That does conclude today's conference.

  • We thank you for your participation.