道富銀行 (STT) 2008 Q2 法說會逐字稿

Good morning, and welcome to State Street Corporation's second-quarter call and webcast.

Today's discussion is being broadcast live on State Street's websites at www.StateStreet.com/stockholder.

This call is also being recorded for replay.

State Street's call is copyrighted, all rights are reserved.

The call may not be recorded for rebroadcast or distribution in whole or in part without express written authorization from State Street and the only authorized broadcast of this call is housed on State Street's website.

At the end of today's presentation we will conduct a question-and-answer session.

(OPERATOR INSTRUCTIONS) Now, I would like to introduce Kelley MacDonald, Senior Vice President for Investor Relations at State Street.

Good morning, everyone.

Before Ron Logue, our Chairman and CEO, and CFO Ed Rush begin their remarks, I would like to remind you that during this call we will be making forward-looking statements relating to the Corporation's financial outlook and business environment, investment portfolio, asset-backed commercial paper program, and consolidation of Investors Financial Corp., among other things.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in State Street's 2007 annual report on Form 10-K and its subsequent filings with the SEC, including in particular, its current report on Form 10-K dated June 2, 2008.

We encourage you to review those filings including the sections and risk factors concerning any forward-looking statements we may make today.

Any such forward-looking statements speak only as of today July 15, 2008, and the Corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

In addition, information related to this webcast including information concerning and reconciliations of non-GAAP measures referred to in this webcast is available in the Investor Relations section of our website under the heading "Annual Reports and Financial Trends."

I would also like to remind you that you can find additional detail regarding the performance of the assets in the Corporation's investment portfolio and of the assets in the commercial paper conduit on our website.

Now I will turn the call over to Ron.

Thank you, Kelley, and good morning.

Let me start by characterizing our performance in view of the continuing market turmoil that all financials have been dealing with since last August.

I think the question for all of us is, how are we going to look once we emerge from this crisis?

The answer for us and for other trust banks, I think, lies in four areas.

First, how is our core business doing and are we continuing to grow revenue?

Second, what will be the effect of future market-driven revenue compared to current elevated levels?

Third, how are we dealing with expense control?

Fourth, what will be the outcome of our on and off balance sheet issues?

Our core business continues to remain very strong as evidenced by our second-quarter results.

Two indicators that are telling of a strong sequential quarter growth -- servicing fee revenue fueled by large new business wins in previous quarters and continuing this quarter and better-than-expected results in asset management fee revenue.

Second, our securities finance revenue continues to be very strong taking advantage of disruptive financial markets, but we would expect this uncharacteristic growth to moderate in the second half of 2008.

Foreign exchange revenue has already begun to decrease this quarter from previously elevated levels, and as Ed will report shortly, we expect net interest margin to increase slightly from our previous outlook.

Third, balancing our spending to ensure a long-term success with the need to consistently generate positive operating leverage has never been more important than it is now.

I'm pleased with our ability to moderate the growth of our salary and benefit expense first quarter to second quarter.

We need to continue to place a strong emphasis on controlling expense and we will.

Last, but not least, the quality of the assets in our investment portfolio and asset-backed commercial paper program continues to be strong, as Ed will discuss.

The respective marks on the investment portfolio and the conduits have stayed pretty much the same quarter-to-quarter.

We currently believe that the investment portfolio is not other than temporarily impaired and that the conduits do not need to be consolidated onto our balance sheet.

Regardless, we have strengthened our capital position and our tangible common equity with the issuance of $2.8 billion of equity capital and by continued strong internal capital generation in the second quarter.

Because of our strong performance in the first half of 2008, we now expect our growth in operating earnings per share to approach the high end of the 10% to 15% range, and operating return on equity to also approach the high end of the 14% to 17% range.

We also believe our revenue growth will exceed the high end of the 14% to 17% range.

So let me talk about our accomplishments this quarter in some more detail.

State Street this morning reported a strong quarter's performance with increased revenue on nearly every line of the income statement when compared to the prior year's second quarter and was up on nearly every line compared to the first quarter of '08.

Compared to the first quarter our total revenue increased 4% and our operating earnings per share, excluding the merger and integration costs in the second quarter of 2008, was up 1% compared to the first quarter of 2008.

Also excluding these costs, we achieved 19.3% operating return on equity in 2008 compared to 19.4% in the first quarter of 2008.

Overall, the results of the first half are very strong.

Even excluding the revenue and operating earnings from Investors Financial and comparing the second quarter of 2008 with the second quarter of 2007, revenue grew 27% and operating earnings per share increased 29%.

Also excluding the merger and integration costs in the second quarter of 2008, on an operating basis we achieved positive operating leverage of 650 basis points, our 15th consecutive quarter of positive operating leverage when measured on a year-over-year basis.

On a quarter-to-quarter basis, we achieved about 30 basis points of positive operating leverage.

Considering the market challenges we are pleased with the strong growth in our core businesses in the first half of 2008.

Compared to the first quarter of 2008, we increased servicing fees 2% and management fees grew a little less than 1%.

Trading services revenue was down 13% in the second quarter from the first quarter, a trend which may continue into the third quarter when we typically experience lower revenues compared to the second quarter.

Also looking at the second quarter of 2008, we enjoyed a certain amount of over performance in securities finance.

Securities finance revenue was up more than 16% comparing the second quarter with the first quarter.

I caution you, however, that you cannot extrapolate the strong results in securities finance revenue in forecasting the second half of 2008.

Typically, we see a decline in securities finance revenue from the second quarter to the third quarter.

Partially offsetting the expected slowdown in trading and securities finance revenue is the expected strength and net interest revenue in the second half of 2008 compared to the second half of 2007.

Ed will provide more details about this shortly.

We have now completed the first 12 months of the consolidation of Investors Financial and we remain confident that we will retain at least 91% of the customer revenue.

As you can see from the press release issued this morning, the performance of the business we acquired from Investors Financial continues to exceed our expectations adding $253 million in fully-taxable equivalent revenue in the second quarter from Investors Financial.

We reported $0.02 in operating earnings per share this quarter from Investors Financial, up from a neutral result in the first quarter.

We now expect the acquisition to be accretive this year, significantly ahead of our original plan.

The consolidation is proceeding according to plan, we have already converted about 47% of the customer products.

As customers convert, we are removing costs while also providing access for those customers to a broad range of new products and services.

Regarding new business won during the quarter, we won $400 billion of assets servicing new business.

Some of the second-quarter wins include, on the servicing side -- John Hancock consolidated an additional $24 billion in assets with State Street to provide custody and fund accounting for 43 additional funds, bringing the total assets service for all John Hancock funds to $125 billion in 228 funds.

The Federal Reserve Bank of New York, as managing member of Maiden Lane LLC, awarded State Street a mandate to provide custody collateral administration and LLC administration services for $30 billion in assets.

State Street renewed contracts with 5 long-standing public fund clients, for whom it services around $181 billion in combined assets.

These included the state retirement and pension system of Maryland, the University of California regents scheme, the Montana Board of Investments, the state of Nebraska, as well as the Minnesota State Board of Investment, a State Street customer for over 20 years.

We also renewed the contract with the Teachers Retirement System of Texas, the fourth-largest public pension fund in the United States, for a variety of custody, accounting, analytics, and securities lending for $110 billion in assets.

Apostle Asset Management, an Australian asset management firm, has appointed State Street to provide custody and investment administration services for AUD2 billion in five Apostle branded funds being offered to local investors.

This quarter we also acquired Deutsche Bank's Swiss fund accounting business, which will enable us to provide fund accounting services for Swiss-domiciled funds.

We will initially service 16 investment funds with approximately CHF4 billion in assets.

State Street Global Advisors added significant new business as well.

San Bernardino, California, County Employees Retirement Association approved investing $360 million in SSgA's liquidity strategy cash portfolio.

Lincoln Financial has selected SSgA for an extensive subadvisory relationship and management of six new investment portfolios and two existing index funds.

In the second quarter, 35% of our new business came from active strategies, a continuing emphasis for SSgA.

Now turning to our balance sheet, net interest revenue and net interest margin again performed very well achieving a 73% an increase in fully taxable equivalent that interest revenue in the second quarter of 2008 compared to the second quarter of 2007 and a net interest margin of 231 basis points in the second quarter of 2008.

Ed will provide further details about these results in our outlook for net interest margin in a few minutes.

So despite the continued turmoil in the financial markets over the past quarter, I am very pleased with State Street's performance, both growth in revenue as well as operating earnings per share.

We will continue to watch expenses closely as we target positive operating leverage on an annual basis and maintain our focus on continued global growth across our business.

Now I would turn the call over to Ed who will provide some of the details of our financial performance last quarter, as well as further information about the performance of the assets in our investment portfolio and the asset-backed commercial paper program.

Thank you, Ron.

Good morning, everyone.

This quarter, again, underscored the strength of our business.

We reported strong growth in both fee and net interest revenue.

Please note that the numbers I am presenting for the first two quarters of 2008 include the results of the acquired Investors Financial business.

Our growth in asset servicing, asset management, and securities finance revenue continued at a combined rate of about 33% compared to the second quarter of 2007.

Trading services took advantage of volatility in the market and securities finance revenue benefited from steepness in the short end of the yield curve.

We also reported strong growth in net interest revenue.

We continued to benefit from the action in late March by the Federal Reserve, however, we expect the benefit of the recent cuts will moderate over the second half of 2008.

I will provide more detail on our net interest income and margin in the outlook for 2008 in a few minutes.

Our assets under custody at June 30, 2008, were $15.3 trillion compared to $13 trillion on June 30, 2007.

Our assets under management stood at $1.9 trillion at the end of this quarter, down slightly from June 30, 2007.

As Ron noted, the business acquired from Investors Financial continued to perform well.

As we reported this morning, total revenue in the second quarter of 2008, including Investors Financial, compared to the second quarter of 2007 was up 39%, and excluding Investors Financial total revenue was up 27%.

Investors Financial contributed $0.02 to the operating earnings per share in the second quarter ahead of our original outlook.

Excluding variable expenses resulting from revenue growth at Investors Financial, in the second quarter of 2008 we saved an additional $69 million.

As a result the savings over the last four quarters is $209 million.

We are on track to achieve our annualized target of $350 million we set in February of 2007.

We previously thought the Investors Financial transaction would be modestly accretive in 2008, excluding the impact of the merger and integration costs.

Due to continued strength and revenue growth, we now expect the acquisition to be about $0.05 to $0.06 accretive to our 2008 results, significantly ahead of our original plan at the time of the acquisition.

I hope you have had an opportunity to review our earnings press release distributed this morning.

Please review the financial statements included with our earnings press release and in our financial trends package on our website for detailed information on our financial results.

Now on to the results.

This morning all of my comments will be based on our operating basis results, excluding the merger and integration costs associated with the acquisition of Investors Financial in the first and second quarters of 2008.

On an operating basis, earnings per share in the second quarter were $1.40, up 31% from $1.07 per share last year and up 1% from $1.39 in the first quarter.

Revenue on a fully-taxable equivalent basis, totaled $2.7 billion for the quarter, an increase of 39.7% from last year's second quarter compared with a 33.2% increase in expenses to $1.809 billion on an operating basis.

Compared to the first quarter of 2008, revenue on a fully-taxable equivalent basis was up 3.8% and expenses on an operating basis increased 3.5%.

Return on equity, on an operating basis, was 19.3% in the second quarter, up from 19.2% in the second quarter of 2007 and down from 19.4% in the first quarter.

Servicing fees were up 28% from the second quarter of 2007, due to the additional revenue from Investors Financial customers as well as increases in new business from existing and new customers, offset partially by an 8% decline in the daily average equity market valuations.

They were up about 2% from the first quarter, due to growth in net new business and a slight increase in daily equity valuations.

Management fees were down 1% compared with the second quarter of 2007, due primarily to the impact of a 10% decline in the average month and equity valuations and a decline in performance fees offset partially by business from existing and new customers.

Management fee revenue was up slightly from the first quarter, due primarily to a slight increase in the average month-end equity valuations offset partially by lower performance fees.

Performance fees were about $4 million, down from $18 million a year ago and from $7 million in the first quarter of 2008.

Our cash and money market assets under management were down slightly, about 3%, from last year's second quarter.

We experienced a 6% decrease in equity assets from the second quarter of 2007, a good performance when compared with the 15% decline in quarter end equity valuations.

Fixed income assets increased about 19% compared to the second quarter of 2007, a rate higher than the market averages.

Increased volatility and higher volumes in our foreign exchange business drove a 30% increase in foreign exchange trading revenue compared with the second quarter of 2007.

For exchange revenue was down 14% from the first quarter, due primarily to lower volatility and a slight decline in volumes.

Brokerage and other fees were up $7 million, or 8%, to $93 million from the previous year's second quarter.

This improvement was due primarily to strength in electronic trading and current ex businesses.

Brokerage and other fee revenue was down 8% from the first quarter, due to a decline in third-party trading revenue offset partially by an increase in U.S.

transition management mandates.

Also the steepness of the short end of the yield curve contributed to the increase in revenue from securities finance in the second quarter compared to the year-ago quarter.

Securities finance revenue was up 117% from last year's second quarter, due primarily to improved spreads partially offset by lower demand and was up 16% compared to this year's first quarter also primarily due to a continuation of improved spreads and the impact of the dividend season in Europe.

We expect that benefit from spreads to moderate into the second half of this year.

We had $672 billion in average securities on loan.

The duration on the securities lending book at June 30, 2008, was 25 days.

Processing and other fees increased 18% from the prior year's second quarter.

This improvement was due to revenue associated with Investors Financial.

The revenue increased 43% from the first quarter, primarily due to structured products.

Asset-backed commercial paper related revenue of $13.2 million was down 23% compared to the second quarter of 2007 and up $2 million from the first quarter of 2008.

Net interest revenue, on a fully-taxable equivalent basis, increased from the second quarter of 2007 by $288 million, or 73%, from $397 million to $685 million and was up $37 million from the first quarter.

In addition, compared to the second quarter of 2007, net interest margin of 231 basis points was up 67 basis points and was up 11 basis points from the first quarter of 2008.

Some of the trends that drove our improved performance in the second quarter compared to the year-ago quarter include -- a larger balance sheet, improved spreads on our fixed rate portfolio caused primarily by the lower-cost funding due to the recent actions by the Federal Reserve, the impact of additional revenue from the acquired Investors Financial business, a steeper yield to curve from overnight to three months, and the impact of our equity offering in June.

Compared to the first quarter of 2008, in the second quarter of 2008 we benefited from improved spreads due to the actions of the U.S.

Federal Reserve, offset partially by a lower rate environment.

We generated lower revenue from non-interest-bearing deposits in our equity.

Now let me turn to the investment portfolio.

The average investment portfolio increased from $67.7 billion to $71.7 billion during the second quarter from the year-ago quarter due to the impact of the Investors Financial acquisition and was down slightly from $73.3 billion in the first quarter of 2008.

Mortgage-backed securities in the second quarter of 2008 represented about 38%, or $27 billion, of the average investment portfolio.

Floating-rate asset-backed securities in the second quarter of 2008 represented about 34% of the average investment portfolio, or $24.6 billion.

We believe this portfolio is conservatively structured and is well seasoned.

Portfolio has been performing well, is diversified and has been withstanding market stresses.

All of the assets are current as to principal and interest.

During the quarter, particularly in late May and early June, we saw credit spreads tighten causing an improvement in the after-tax unrealized mark of about $500 million.

But offsetting that we had an increase in the after-tax unrealized mark of about $600 million due to the impact of higher U.S.

rates on fixed rate securities.

As a result, while the tone of the market is slightly improved, the unrealized mark-to-market loss after tax is about $2.0 billion up about $72 million from March 30, 2008.

We continue to believe that these prices are not reflective of the underlying value of the securities if held to term, but indicate a continuing lack of liquidity in the fixed income market.

In past quarters I have presented considerable detail about the investment portfolio, specifics about the ratings of each asset type, and considerable detail on subprime portfolio.

I recently have also added data on the unrealized loss by asset type as well as stresses we apply to each of these assets to give us confidence as to their underlying quality.

Those are updated and available to you on our website.

As I just indicated, the amount of unrealized loss has not changed materially from the first-quarter level and I strongly urge you to review those slides.

In addition, you are probably aware of the downgrades to the mono-line insurance providers during the past quarter.

Those downgrades had a minimal effect on the unrealized losses in our investment portfolio.

Almost all of those downgrades affected our municipal bond portfolio, which is in an unrealized gain position at the end of the quarter.

Now as to our outlook for net interest revenue for the remainder of 2008, last quarter I revised our outlook for net interest margin for 2008.

I said that we expected the margin to be between 200 and 210 basis points, probably near the high end of the range.

In the current environment, we now expect our margin on average for the full year to be about 215 basis points or slightly higher based on the following assumptions -- that we maintain the existing favorable mix of customer liabilities; an expectation that the investment portfolio will reprice as about $7 billion in older, fixed rate securities mature in 2008, but that these will be reinvested on average at modestly lower rates than in 2007.

Also I should mention that we continue to minimize our portfolio reinvestment as we maintain our liquidity in the face of the current market environment.

Lastly, that the level of non-U.S.

transaction balances remains at current levels.

In February we provided an outlook that the ECB will reduce rates by 50 basis points to about 3.5% by year-end and that the Bank of England will reduce rates by about 75 basis points to about 4.75%.

Since the ECB has already raised rates once in early July, we now believe that these two central banks will either hold steady from here or possibly raise slightly, either of which action is slightly beneficial to us for the rest of this year.

As the U.S.

Fed stops cutting rates the benefits we have seen -- been enjoying will abate.

So in the second half of the year we may not see the net interest margin at the level we reported this quarter.

We continue to expect our '08 average balance sheet to be roughly flat with the average balance sheet in the fourth quarter of 2007.

Our duration has not changed significantly from year end -- our assets are about 11 months and our liabilities are about nine months.

The investment portfolio duration is about 1.5 years, down slightly from the second quarter of 2007 and flat with the first quarter of 2008.

I will now turn back to expenses, and just as a reminder, I am speaking about expenses on an operating basis.

Salaries and benefits expenses increased 31% compared to the second quarter of 2007, due primarily to the impact of additional staff from Investors Financial and higher staffing levels to service new business, as well as increased benefits expense.

Compared to the first quarter of 2008 salaries and benefits expense was approximately flat, primarily due to a lower level of incentive compensation offset partially by higher benefit cost and the impact of increased staffing levels to support growth.

Transaction processing expenses increased 22% compared to the year-ago quarter, primarily due to the acquisition of Investors Financial and increased volumes in asset servicing and the trading businesses.

They increased 6% from the first quarter of 2008, due primarily to the impact of the receipt of a depository rebate in the first quarter.

Expenses for information systems and communication increased $36 million, or 28%, primarily due to the impact of Investors Financial and costs to support growth in Europe.

Occupancy expense increased 17% from the second quarter of 2007, due primarily to the cost associated with Investors Financial and was up 5% sign from the first quarter of 2008 due to investments to support growth, particularly in Europe.

Other expenses were up 63% compared to the year-ago quarter, primarily due to the impact of professional fees and the amortization expenses associated with Investors Financial as well as securities processing costs.

They were up 15% compared to the first quarter of 2008, primarily due to professional fees and globalization efforts.

Our tax rate for the first quarter was 34%, flat with the first quarter.

As we disclosed in this morning's press release, we completed the divestiture of our 50% investment in CitiStreet in early July, resulting in a gain of about $0.47 per share.

Taking into account this to divestiture, we expect the effective tax rate for 2008 to be a 34.6%.

Excluding the impact of the divestiture of CitiStreet, the expected effective tax rate for 2008 remains at 34.0%.

Now turning to our capital ratios.

The principal capital ratio that we managed to is the tier 1 leverage ratio.

We have historically targeted between a 5.25% and 5.75%, but given the market environment, we expect our leverage ratio to grow to a level above the top of that range in order to preserve flexibility in what appears to be continuing volatility in the market.

At June 30, 2008, our tier 1 leverage ratio stands at 8.24%, up from 6.09% as of March 31, 2008.

Our tangible common equity ratio is 5.40%, up from 2.92% at March 30, 2008.

The increase was driven by the $2.8 billion equity issuance we completed in June and approximately $550 million of organic capital that we generated in the second quarter.

Next I will briefly describe the conduit assets in our asset-backed commercial paper program.

As in the past, you can find a detailed quarterly review of the assets displayed by type, country of origin, and ratings on our website located with the second-quarter materials.

Also there you will find the unrealized after-tax mark-to-market losses for each asset type and the stresses we applied to them.

In the interest of time, I will not discuss them in detail today.

As the June 30, 2008, the conduits held assets of $28.4 billion, nearly flat from a $28.3 billion on March 31, 2008.

The asset amortization was offset primarily by new asset purchases, as well as the impact of the continued weak dollar.

Also during the quarter, we issued $15 million of additional subordinated debt to further mitigate consolidation risk, bringing the total amount of first loss notes available to the conduits to $67 million.

As I stated last quarter, we created this program in 1992 primarily to address customer requests for high-quality, highly-rated commercial paper.

The conduits have never suffered a credit loss on any asset they purchased, evidence of our strong credit discipline.

82% of the assets are rated single A or above.

In the second quarter, 125 additional securities were downgraded due to the downgrade of the mono-line insurance providers.

None of the assets in our conduits are subprime, nor are any structured investment vehicles in the conduits.

The unrealized loss on the conduit assets as of June 30, 2008, is about $1.6 billion after-tax, again reflective of the illiquidity in the market, up from $1.5 billion after-tax at March 31, 2008.

The assets continue to have an average -- weighted average maturity of about four years and the paper has a weighted average maturity of 20 days, up from 16 days at March 31.

As of June 30, we had funded about $212 million of our asset-backed commercial paper on our balance sheet.

All the securities in the conduits are current as to principal and interest.

Due to the high quality of the assets and their performance, we do not currently believe we need to consolidate the conduits.

On a pro forma basis, as of June 30, the consolidation of the conduit assets onto our balance sheet would reduce our leverage ratio by about 117 basis points from 8.24% to 7.07% and the tangible common equity ratio about 182 basis points from 5.40% to 3.58%.

From a funding standpoint, the risk of consolidation is included in our contingency funding plan.

As of June 30, 2008, we carried about $18 billion in liquid assets on our balance sheet, given the market environment.

In addition, we believe that we can access multiple sources of liquidity to fund any asset purchases from the conduits.

Our sources of this liquidity include borrowing from the overnight interbank or repurchase markets, issuing corporate commercial paper, issuing bank CDs and time deposits, and/or accessing the Fed discount window.

So overall in the second quarter, we continued to perform well in what we think was an economically challenging period.

We hope that you review the information we have provided on our website, adding further detail to our discussion of the investment portfolio and our conduit program.

Now I will turn the call back to Ron.

Thank you, Ed.

As outlined at the beginning of this call, I am very pleased with State Street's performance, both on a sequential quarter and year-over-year basis.

Not only have we built momentum in growing our core business, but also we have proven our resiliency in the face of quite unprecedented market conditions.

Although the declines in the equity markets have pressured our fee revenue in the second-quarter compared to a year ago, our new business won over the past few quarters has contributed to that strong performance.

We continue to benefit from our focus and our ability to cross-sell into our existing and acquired customer base, as well as our solid global footprint.

Our strong position in our trading business and in securities finance benefited the second-quarter results, which should moderate in the second half of the year.

While our net interest revenue continued to be strong, we can expect those results to moderate also as we will no longer benefit from the Fed rate cuts of late 2007 and the first quarter of 2008.

We look forward to continued stronger-than-expected performance from SSgA as the new asset management team makes an impact.

I want to assure you that we continue to watch our expenses carefully, recognizing that these challenging times continue.

We are committed to achieving annual positive operating leverage, so we must be sure that our rate of revenue growth exceeds our rate of expenses growth even in more difficult markets.

Specifically, I will just remind you of my earlier comments regarding our outlook for 2008.

The achievement of all of these goals excludes the non-operating gain from the divestiture of CitiStreet, which closed in the third quarter.

We expect our earnings per share on an operating basis, excluding merger and integration costs, but including the recent capital raise, to increase 10% to 15% compared to the 2007 operating basis results of $4.57 per share, approaching the high end of that range.

We expect our operating return on equity to be between 14% and 17%, also approaching the high-end of the range.

We expect our revenue growth to exceed the high-end of our 14% to 17% range.

We revised our outlook regarding our level of performance to these goals based on the strength of the first half of 2008.

In the second half of the year, we anticipate the comparisons will be more challenging.

Our consolidation of Investors Financial continues to outperform our original expectation, retaining 91% of their revenue and earnings $0.02 per share, excluding the merger and integration costs in the second quarter.

In addition, based on our performance in the first half of 2008, our core businesses are performing well, fueled by continued new business wins and a strong pipeline.

We continue to watch our costs carefully as we head into a more challenging period.

Ed and I will now be happy to take your questions.

Thank you.

(OPERATOR INSTRUCTIONS) Glenn Schorr, UBS.

Hi, thanks very much.

Did you -- I'm not sure if I missed it or not -- did you talk about where you envision the size of the conduit and securities portfolio to be as of year-end, based on maturities coming due and pay downs?

Yes, Glenn, this is Ed.

In terms of the conduits, the maturities in the conduits are about $1 billion a quarter.

We are committed to right-size those conduits, as we have said since we have been talking about them in great degree since the last year.

The issue there is though that we cannot just have a linear decay, because of the impact of the FIN 46 models.

So I don't have a target that I could say that we are reaching for by the end of the year, but our commitment is still the same.

We are looking to decrease the size of the conduits overall.

In terms of the portfolio, I would say it's probably going to be in line with where it is now, in the $75 billion range or so, at year end.

We don't anticipate many changes there.

Okay.

Then when unrealized losses come up, whether they be produced by higher treasuries or wider spreads, how do the rating agencies and the regulators view the impact on capital ratios?

In other words, is it the same as if it was produced by lower earnings in the quarter?

Do they test the impairment test, like what are they looking at when they see the same numbers we look at?

They are looking at the entire picture.

I don't think that an unrealized loss is viewed the same as less -- a lesser level of core earnings, certainly.

But the fact that the unrealized loss increases or decreases are certainly taken into account by both the regulators and the rating agencies when they look at our capital position.

We have ongoing dialogue with both of them.

A couple of quickies.

Other expenses up big?

I saw some comments in the text part of it related to integration, part of it was related to securities processing.

Is there -- was that a little bit of a jump up this quarter and you should see some moderation in the second half?

Glenn, this is Ron.

As we said in the past, when we get opportunities to invest in some places we usually take that.

You will find professional fees up, for example.

So I think this is another example of us taking advantage of spending some money when we can.

Okay, that is good to hear.

Maybe last one, any word back to the -- any latest word in terms of FASB's comments on potential consolidation comments around FAS 140 and FIN 46 and removing the QSP rule in terms of timing and potential construct of changes there?

Our understanding, Glenn, is really just from public sources, which is that the FASB is expected to issue an exposure draft around the end of this month.

The contents of that are still, I guess, up in the air as far as I know.

The issue of the FAS 140 affects the QSBEs, which does not affect us.

The issue of the FIN 46 revision is the thing that does potentially affect the consolidation requirement, so the rules under which conduit consolidation would be required.

But end of the month I think is something to target for from a release standpoint.

Okay, well thanks very much.

Nancy Bush, NAB Research.

Good morning, guys.

Hi, Nancy.

A couple of questions here.

Everybody, I think, is having a hard time getting their head wrapped around where net interest revenues go from here.

, because it has been such a bigger piece of the earnings equation I think this year than anybody expected.

How should we think about net interest revenue going forward?

If the Fed does nothing or for some insane reason decides to tighten, how do you look at NIR going

I really don't want to get too far ahead of things and talk about 2009 yet, Nancy, given the uncertainty.

I will tell you our thinking in terms of the second half of this year.

As I said, we expect the full year to be, from a margin standpoint, in the range of 215 or maybe a little bit above.

That obviously implies a little bit of a weaker second half than what we had in the first half.

The first half we think was extraordinarily strong, mainly driven by the pace and the depth to which the U.S.

Fed cut rates.

So we are expecting to see less of a benefit there in the second half as that works through.

We are anticipating the U.S.

Fed to stay the same at about 2%.

To your question if the Fed were to decide to increase rates, that would have a depressing effect on our second half expectation for net interest margin.

So that is a possible downside to our forecast.

We are expecting though strong transaction deposit flows to continue, which we have had for a while.

Obviously, if the opposite were to be the case, we could have a slightly negative affect on the margin.

We are expecting the yield curve at the short end to remain fairly steep, as it was in the first quarter -- in the first half of this year, excuse me.

We think the ECB and the Bank of England will stay about where they are and we are expecting an average balance sheet size in the $140 billion range.

So you can take the opposite side of a lot of factors that I just said and construct a scenario where perhaps our margin compresses in the second half.

We are, as I said, expecting a less robust net interest revenue and net interest margin second half of the year.

But overall in the range of 215 or so for the full-year from a margin standpoint.

Thank you.

Secondly, losses in the investment portfolio since quarter end, has there been any material change?

Since quarter end the losses actually widened out a little bit, from June 30 it was just about $2 billion on the nose after tax.

It's a little shy of $2.2 billion as of the close of last Friday.

$2.185 billion is the exact number as of last Friday.

Thank you.

Ron, just a question for you.

Given the environment, can you just give us -- I think we are all sitting here stunned.

Can you give us your take on how this -- and you have been around the banking industry for a while -- stacks up to the '89/'91 period?

I would assume that you are going to be one of the beneficiaries of flight quality here and whether indeed you are seeing that?

Well, I think '89 and '91 was a very difficult time, probably the most difficult that I have ever experienced.

This may be approaching that, I am not sure if it's there yet.

But I think they were a lots of lessons learned during that period of time and I think we have got a number of people in the company that have experienced that.

My sense is that we have been and will continue to prepare well for any extended period of time like that.

We have seen, I guess you could call it, a flight to quality.

We have seen cash balances increased somewhat.

I would expect that would continue over time.

I think we are going to be in a position to deal with that so that would be an expectation of ours as history has proven.

Thank you.

Mike Mayo, Deutsche Bank.

Hi, good morning.

Two follow ups.

You have said the unrealized securities losses, what are the unrealized losses in the conduit at quarter end?

Have you moved any of those assets on balance sheet since quarter end?

This is Ed, Mike.

In terms of the conduits, same thing but to a lesser degree.

From June 30 through last Friday the 11th, the loss on an after-tax basis, increased by about $60 million --

So not much, okay.

-- a little bit shy of $1.7 billion after tax.

In terms of any assets from the conduits coming on the balance sheet, the answer is no.

How much, again, of the assets from the conduit came on balance sheet this quarter?

This quarter?

In the second quarter.

Second quarter was $850 million of AAA rated securities under a LAPA.

Oh, so that was first quarter.

First quarter.

None this quarter, Mike.

So you moved zero additional assets from the conduit on balance sheet in the second quarter?

Correct.

All right.

So you have moved no additional assets on balance sheet.

If the FIN 46 decision comes out in your favor, what do you do with all the capital you raised recently?

I saw that as an insurance policy in case you needed to use it.

Do you want to keep that insurance policy around for longer or might you put some of that capital to work?

Well, in a perfect world, Mike, we would hope that over time the marks would come in and that opportunities would present themselves to us.

That is how we would like to see that play out, but who knows.

Okay.

Then, separately, your pipeline, the backlog, kind of tone of the market.

Very strong, very strong.

Again, this quarter some real good wins.

I think the other thing that I probably didn't spend some time on, but I talked about a lot of rebids won, just about all of the rebids that we had we won.

Six huge rebids.

I think if you add Texas Teachers plus the other five, it's about -- close to $300 billion of assets won.

We have been extremely successful in retaining our business in the last couple of quarters.

Can you give some kind of context out there?

What does really strong pipeline mean as a percentage of, say, current revenues or assets under custody?

Well, I don't know if I could give it to you at that percentage, but probably more in absolute.

I think we have been winning somewhere between $400 billion and $600 billion of assets for the last two or three quarters, which has -- traditionally has been more than we have done, if you go back and look in recent years, that has been a lot more.

I think some of it has to do with flight to quality.

I think some of it has to do with dislocation of others in the marketplace or preoccupation.

So would that be some of the other big five players, big four or big five players, or the tier below that?

No, it would be the big five.

Okay, all right.

Thanks.

Ken Usdin, Banc of America Securities.

Thanks, good morning.

A couple of quick clean up ones.

Can you just confirm again that the CitiStreet gain is not included in your operating guidance?

It is not.

Okay.

What again is the TC expected impact from the gain in the third quarter?

It would be --

The benefit?

-- it would be about 14 basis points, Ken.

Okay, great.

Are there any other potential calls on capital out there, whether it's SSgA reserve or SILO and LILO exposure, etc., that we may not have seen yet?

Ken, in terms of the second-quarter results, the issue of SSgA reserve was evaluated as was our reserve for our SILO exposure.

Both were considered to be adequate.

So the answer to your question is no.

Okay, great.

Then as far as the investment portfolio, obviously, the incremental downgrades that there were this quarter were mostly related to the mono lines.

As you look at the portfolio vis-à-vis the rating agencies, how do you generally continue to feel about forward-looking waves of downgrades, as far as the overall credit environment is concerned?

Taking your points about money-good quality of the portfolio, but does any change as far as the potential to have to even potentially impair investments even if they are "money-good" or is it just status quo?

Well, I think it's more or less status quo.

I think that we have been doing a lot of work for the last number of quarters that we have been talking about.

Our work supports what we believe and what we think the rating agencies believe in terms of the asset quality.

So at this point, I'm not anticipating that we would have significant downgrades or significant impairment charges.

That could, obviously, always change if the circumstances change.

But we feel pretty comfortable with where the portfolio is and where the rating agencies are and where our stress tests come out.

Okay.

The last question is just as far as your forward thinking as far as the guidance and the implied raising of the second-half guidance, even though you are talking about making sure we don't run rate second-quarter results.

I'm just wondering if you could give us a thought process on what is better, what is worse versus your prior own budgeting expectations rather than consensus expectations?

So as you look forward, just wondering where those implicit hedges are in the business model, if any?

Well, Ken, this is Ron.

I would say they are probably in a couple of areas.

First of all, the quarter revenue strength is very strong.

We want a lot of new business.

We continue to install a lot of new business.

We have also been very successful in cross-selling, especially into the investments financial book of business.

That seems to continue, so we feel good about that.

We are also -- we also have quite a focus on expense control, which I talked about in the past.

If in fact you believe we are going into a slower growth environment, we have to deal with expenses today, not next quarter or the quarter after that or next year.

We are doing that and we are doing it carefully.

And when we get an opportunity to invest a little money we do that.

So I think core revenue strength, expense control, and I think net interest revenue, at least for the rest of the year, will be pretty much beneficial to us.

Okay and one quick last one.

Just on the conduit question, Ed, to your point before about issuing some more subdebt, can you just speak about how comfortably above the trigger thresholds for, I guess, automatic consolidation as opposed to on your own doing; that the conduits remain -- like I don't know, how much cushion there just is on both the profitability test and the credit test?

Sure.

There is no automatic trigger, if you will.

It is governed by our FIN 46 model.

But to put it in the context of how much subdebt we need versus how much we have and, therefore, the cushion, Ken, on our two big conduits, the ones that are over $10 billion each, one has an 84% cushion.

That is excess subdebt versus required subdebt.

And the other one has a 50% cushion.

So we have significantly increased our cushions relative to our FIN 46 model requirements.

Okay, and it's a non-issue with the smaller ones?

Yes.

Smaller cushions, but much smaller conduits.

I was just giving you the big ones that would have the most balance sheet impact if they were to come on.

Okay, got it.

So you feel that there's a lot of room that you just -- you aren't anywhere close?

Would the only reason you brought the conduits on be because FIN 46 changes?

Yes.

Okay, thanks.

Sorry for the extra questions today.

I appreciate it.

No problem.

Brian Bedell, Merrill Lynch.

A couple, just a few quick questions.

First on the foreign deposit costs, what is your flexibility to bring them down further?

We've already seen them come down from 2.24% in the second quarter -- I'm sorry, in the first quarter down to 1.53% here in the second quarter, and that --.

Brian, can you talk more into your telephone?

Sorry about that.

Sorry, can you hear me now?

Much better.

Sorry about that, yes.

Foreign deposit rates, what is your flexibility to bring that down more?

We've seen that come down from 2.24% down to 1.53% in the second quarter here.

That is about a 70 basis point drop despite the ECB I guess in the third quarter raising rates here.

I'm just trying to gauge how to much more flexibility you have to take that down further or do you think there is -- that could move up a little bit second half?

I don't think you should be thinking about a lot of flexibility there, Brian.

One of the main drivers of that decline was due to the non-dollar -- I'm sorry, the dollar component of that, which is euro dollar.

So those deposits benefited from the decline in the U.S.

rate environment, which is manifesting itself in the numbers that you just quoted.

We are not anticipating the Fed, as we said, to decline any further.

So I don't think there is a lot more downside there in terms of decreasing those deposit costs.

Right.

You still see inflows, despite being paying rates that are lower than your peers, you still see about $5 billion of inflows of custody deposits.

Do you expect to be able to retain that or do you think we will see some switching out in the second half?

Well, I mean, we have been retaining it pretty steadily and actually growing it a little bit so far.

So, yes, we do expect to retain it, although coming into the year we said we didn't think that those deposits would exhibit the growth in '08 that they exhibited in '07.

That has really not been the case, but, yes, we expect to retain it.

One potential upside there is that if, for some reason rates were to go up in Europe, the ability to lag pricing could present itself again.

But we are really not expecting that, as I said, in our rate forecast.

Right.

So actually that brings me to the next question.

In terms of reinvesting the $7 billion of [subtext] running off the balance sheet, what do you expect to invest that in?

Is that mostly going to be invested in Europe?

No, not necessarily.

Some of it may be, but, overall, we are expecting to continue to invest it very conservatively, very short given the disruptions we have talked so much about.

Right.

So you are going to stay away from credit risk I assume?

Yes.

Yes, okay.

So if the ECB and Bank of England do raise, you might invest a little bit more in Europe and then try to lag the deposit rates on the foreign side?

Yes, perhaps.

Certainly, the deposit rate lagging is a potential if they were to raise.

Right, right, okay.

Then just on client conversions, Ron, you talked about $400 billion of new business being won in the second quarter.

Can you -- I assume all that will be converted in the second half?

Then if you can talk about what is also left to be converted in the second half from prior wins?

There is some to be -- left to be converted from prior wins.

Most of what we talked about today will be converted in the second half of the year.

Any magnitude of what is left to be converted in the second half?

I'm sorry, Brian.

I couldn't hear that.

Any magnitude of what is left to be converted in the second half?

Is it relatively small compared to the first --?

Oh, I don't know.

Maybe half.

Half of that, okay.

Then what is your assumption for the average S&P 500 level with the new guidance?

1350 for the full year average.

You are staying at 1350, okay.

Yes.

Okay.

BGI at repricing, when does that occur exactly?

I mean there is no -- we don't talk about that.

That is in the run rate essentially -- or --?

Yes.

The renewal date has already past, is what you are saying isn't it?

Yes.

And it's in the run rate?

Yes.

Okay, great.

Then just the processing fees up to $77 million from -- I think I may have missed that in your comments -- from $54 million in the first quarter.

What was that due to?

I didn't hear the question, Brian.

I'm sorry.

The processing fees going from $54 million in the first quarter to $77 million in the second quarter.

I'm just trying to get a --.

That is really due to the absence of the charge that we took in the first quarter to move the conduit assets onto the balance sheet.

Oh, okay.

So it would be the absence of the charge, so other than that, it's kind of status quo for the quarter.

Okay.

So your run rate is in the 70s there basically?

Right, exactly.

Okay, great.

Then just one last question.

What is your flexibility to reduce expenses in the second half, if we are in a tougher revenue environment for whatever reason?

Do you guys --?

Well, we are looking at that right now, Brian.

Obviously, as you know, we are in a high fixed cost business so we take a look at what we can do.

Obviously, we need to make sure we hire the people we need to do the processing, but we don't necessarily have to hire as many senior people.

So that is one of the people issues and then we look at one of the variables is the professional fees and the contract expenses that we do have some flexibility in increasing or decreasing over time.

Right, okay.

So should we think of the other expense line as being a little flexible?

I guess on the comp line as well, you can basically take down the --?

Yes, on both lines.

Okay, great.

Thanks so much.

Thomas McCrohan, Janney Montgomery Scott.

Good morning, Ron and Ed.

How are you?

Good.

Hi, Tom, how are you?

Alright.

I had a -- just want to understand how you guys are approaching unrealized losses for both the conduit and the investment portfolio?

Should we go under the assumption that the methodology using to value the securities for both conduits is the same?

Yes.

Yes, it is.

It's the same for the asset classes that are the same.

The conduits have more broker-quoted prices than the portfolio does.

The portfolio was virtually all service-driven.

But for the asset classes that are common to both, it's the same methodology.

It seems that -- maybe you can add some clarification -- it seems like your -- the methodology seems a little more conservative on the conduits and here is why I'm coming to that conclusion.

With just --.

Tom, you are breaking up.

Can you try to speak a little more slowly?

Is this better?

Yes, much better.

Yes.

Okay.

It seems like the conduit assets, the valuation methodology seems to be a little bit more conservative versus the securities portfolio.

The way I'm arriving at that conclusion is if you look at, say, page eight of your PowerPoint presentation for the conduits, you have $15 billion worth of mortgage-backed securities, $3.8 billion of which are U.S.

residential mortgage-backed securities.

As you said in your prepared remarks, there is no subprime in that bucket of $3.8 billion of U.S.

residential mortgage-backed securities.

The mark on that portfolio is about 19%.

So if you take the unrealized losses, compare it to the face value, you are carrying those at about $0.80 on the dollar.

Conversely, if you look at the securities portfolio, you have $5.7 billion of subprime assets, which are marked at $0.90 on the dollar, assuming the unrealized losses (inaudible) to $92 million, as of the quarter, is correct, which I'm sure it is.

But you have assets in the conduit that don't include subprime, that are related to mortgages that you are marking at $0.80 on the dollar.

You have $5.7 billion of subprime assets on your balance sheet that you are marking at $0.90 on the dollar, so either I'm just looking at it the wrong way or I just want to get some insight on that.

I think you have to look at a level below the aggregates.

The methodology and the service that we use for both of those asset classes is the same.

So while I don't dispute your math in terms of average dollar price, the build up to the aggregates is what is most important at a CUSIP level.

The subprime assets -- 62% are rated AAA.

Right.

The U.S.

residential mortgage-backed, which don't include subprime, 72% are rated AAA.

So just on the surface, on your numbers, it looks like it's a much more credit risky, but you are marking it down more than the securities portfolio.

Relative to the subprime specifically, Tom, you have to look at the 62% AAA being actually a positive factor because of the pay downs that we are receiving on the securities.

If you look back at the AAA component over time, you will see that it has declined from a much higher level down to the current level.

That is because of the structure of those securities where the payments that we get come down from the top and the losses that are incurred come up from the bottom.

Since we are at the top of the stack, from a credit perspective, we are receiving pay downs and that is why we say none of those securities are in arrears has to principal or interest.

So it's simply the mathematical calculation of AAA and AA bucketing, relative to the pay downs that is driving the 62% number that you quoted.

It's actually a good thing.

What is the average FICO for that subprime exposure?

Do you have that?

I can find it.

I'm sorry, I don't have it at hand.

I can get it for you.

I will get it for you, Tom.

Thanks, Kelley.

Wait a minute, it's 626.

626, okay.

Thanks for squeezing me in.

Okay.

Ladies and gentlemen, we have reached the end of allotted time for questions and answers.

Are there any closing remarks?

No, thank you.

Thank you for participating in today's conference call.

You may now disconnect.