道富銀行 (STT) 2009 Q1 法說會逐字稿

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

Today's discussion is being broadcast live on State Street's Web site 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 expressed written authorization from State Street and the only authorized broadcast of this call is housed on State Street's Web site.

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.

Please go ahead, ma'am.

Before Ronald Logue, our Chairman and CEO, and CFO Ed Resch begin remarks I would like to remind you during this call we will be making forward-looking statements.

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 2008 Annual Report on Form 10-K and its subsequent filings with the SEC.

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

Any such forward-looking statements speak only as of today, April 21, 2009, and the Corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

I'd also like to remind you that you can find slide presentations regarding the Corporation's capital, investment portfolio and asset-backed commercial paper conduits as well as our first quarter earnings press release which includes reconciliations of non-GAAP measures referred to on this webcast can be accessed in the investor relations portion of our Web site as referenced in our press release this morning.

Ron?

Thank you, Kelley.

Good morning, everyone.

All of us, trust banks, commercial banks, investment banks have been through and continue to go through the most challenging of times we've seen in decades.

Financial institutions have all dealt with similar problems and we all have our own unique issues to address.

At State Street, we look at the issues we face from two perspectives, how we manage through this current crisis with the most favorable financial results given the market environment, and just as important, how do the decisions we make now position the Company to take advantage of the emerging opportunities as the economy turns around realizing that we will be operating in a more regulated, deleveraged world.

We think we have an advantage over some of our competition because our business is focused upon servicing institutional investors rather than on traditional banking activities such as making loans, commercial or consumer.

Having said that, we do have issues to deal with and we are taking steps to do so.

I want to talk about how we are reshaping the Company to operate more efficiently in the future and how we are paying close attention to building the type of balance sheet that will be necessary to support our business in this new environment.

Amid this uncertain environment, this morning we announced results that are favorable in light of the challenges we in the industry will continue to face this year.

At the same time that we continue to maintain positive earnings throughout the market crisis our regulatory capital ratios also remain strong.

Our Tier 1 capital stands at 19.13%, and our Tier 1 leverage ratio stands at 10.44%, each at March 31, 2009.

We are implementing our tangible common equity improvement plan that we announced on February 5 at our investor and analyst day and increased our pro forma TCE ratio which assumes the consolidation of the asset-backed commercial paper conduits that we sponsor.

As of March 31, 2009, the TCE ratio is 5.87%.

And the pro forma TCE ratio is 2.22%, an improvement in the pro forma ratio of 103 basis points compared to December 31, 2008.

Our TCE ratio when calculated on a risk-weighted assets is 8.15%, and on a pro forma risk-weighted basis is 3.34%, each at March 31, 2009.

Ed will discuss the details of this plan and our assumptions in a minute.

We're also making progress reducing the size of our asset-backed commercial paper program, which stood at $29 billion as of December 31, 2007, and was about $23.9 billion as of December 31, 2008, and at March 31, 2009, was $22.5 billion.

As I said, we are making progress on our TCE improvement plan, the unrealized after tax loss in the investment portfolio has improved about $465 million since December 31, 2008 from approximately $6.3 billion to approximately $5.9 billion as of March 31, 2009.

The unrealized after tax loss in the conduit assets has remained about flat with December 31, 2008.

As of last Friday, April 17, the unrealized after tax loss has improved another $91 million to $5.8 billion in the investment portfolio compared to March 31, 2008.

Some of the highlights of the recent quarter include achieving positive operating leverage of 440 basis points compared to the first quarter of 2008, significantly reducing expenses in the first quarter compared to the first quarter of 2008 most notably in salaries and benefits as well as in other expenses.

$1.8 billion of assets in our investment portfolio either matured or paid down at par in the first quarter despite an average price of $0.91per dollar at December 31, 2008.

Through March 31, 2009, all of the assets in both our investment portfolio and our conduits continue to be current for principle and interest and we have had no defaults.

Although hedge fund markets continue to deleverage, we continue to win mandates in servicing alternative funds as funds are beginning to move from prime brokers to independent third party administrators and custodians.

Since the beginning of 2008, only one of our hedge fund clients has closed its business.

Our private equity business has added five new clients and has reached $138 billion in assets under administration.

In total, our alternatives business has added 14 new clients, eight new hedge funds, five new private equity funds and one new client using our global risk services.

Our core business continues to perform well as overall declines in asset-based fees are partly offset as we integrate the winds from the fourth quarter and first quarters for both servicing and management.

As investment managers are faced with weak markets and increasing expenses, they are looking to us to turn some of their fixed costs into variable costs.

We won mandates for about $111 billion of assets to be serviced in the first quarter.

We believe our middle office offering which is now built out and operating at scale is a key differentiator for State Street and will be a competitive advantage as large investment managers seek to control fixed costs through outsourcing arrangements.

We've been in this business for nine years and have carefully built out this platform that is adaptable to markets worldwide.

Let me briefly be a little more specific about some of our recent wins.

Among the 14 wins in alternative investments in the first quarter, we've been appointed to provide fund administration services for SeaChange Investments.

We're also now providing custody in foreign exchange service for the corporate and group services division of Canadian Western Trust, a wholly owned subsidiary of Canadian Western Bank.

Orlando Health Care awarded a custody and accounting mandate to us for $500 million in assets.

Canadian Broadcasting Corporation Pension Board of Trustees awarded us a $1 billion mandate to provide custody, accounting and securities lending.

M&G, a UK investment manager, awarded us a 5.8 billion pounds mandate to provide unit trust pricing and funds accounting.

At State Street Global Advisors, we are seeing demand for our passive index strategies as well as our ETFs with net new business in the first quarter of 2009 of about $37 billion.

State Street Global Advisors has been appointed as a portfolio strategist firm by Genworth Financial Wealth Management, a Genworth financial company, to manage a series of six tactical asset allocation portfolios.

The portfolios will be implemented using State Street's industry leading Spider exchange-traded funds.

SSgA also won a $160 million fund management mandate from [Foncine] Funds, an Italian fund that represents about 168,000 workers in the chemical and pharmaceutical industries.

The Kingfisher Pension Scheme and Retirement Trust London, added an incremental 40 million pounds to a passive global fixed income portfolio.

In the first quarter, we launched four new exchange-traded funds and also announced that Spider gold shares surpassed $30 billion in assets making it the second largest ETF by assets in the world.

While we believe the Company remains positioned to achieve its long-term goals of annual performance, those being 8% to 12% growth in operating revenue, 10% to 15% growth in operating earnings per share, and achieving a 14% to 17% operating return on common equity we have taken steps to align our expenses to a weaker market environment.

We believe we are well positioned for an economic recovery.

Given the continued unsettled economic environment and more weakness in the first quarter than we expected, we now believe that in 2009 we will achieve nearer the weaker end of the range as we established at our investor and analyst forum in February.

Operating revenues to decline between 8% and 12% versus 2008, operating earnings per share to decline between 12% and 16% versus 2008, and operating return on equity to be between 14% and 17%.

Given the more than 40% declines in the S&P 500 and in the MSCI EAFE indexes over the past year, our servicing and management fee revenue performed well in these market conditions.

Servicing fee revenue was down 20% versus the decline in the daily average valuation in the S&P 500 of more than 40% compared to the first quarter of 2008.

And compared to fourth quarter, was down 9% versus an 11% decline in average daily equity valuations.

Management fee revenue was down 35% compared to the first quarter of 2008 versus the decline of 40% in average month and equity valuations compared to the previous year's first quarter, and was down 13% compared to fourth quarter of 2008 where average month end equity valuations down 15% compared to that quarter.

Although trading services and securities lending in the first quarter of 2009 declined sharply from the fourth quarter of 2008, we gained new business from clients who have left their former providers or have decided to distribute their risk a bit more.

Until markets begin to repair and resume dome degree of normalcy, we expect softer revenue to continue particularly in foreign exchange and in securities finance.

What is important to understand is that we have used this crisis as the basis for realigning our infrastructure to operate more efficiently and to be able to accommodate volume without adding significant expense.

The reduction in force was not a flat 8% cut in staff.

It was a structured exercise, realigning units, combining positions, transferring work, and thinning management levels.

We are well positioned to add more efficiently and more profitably the business we continue to win.

Now, I'll turn the call over the Ed.

Thank you, Ron.

Good morning, everyone.

I'm sure our approach to a number of issues is of interest to you, so I'll touch on them before beginning my review of the quarter.

First, our progress on our tangible common equity improvement plan that we announced at our investor and analyst day on February 5.

Two, our view of FASB's announcements regarding FAS 157 and FAS 115, as well as changes to the after tax on realized loss in our investment portfolio and asset-backed commercial paper conduits.

Three, the potential impact of the newly announced government program called PPIP, for Public Private Investment Partnership, on the industry and on State Street in particular.

Four, the $84 million loan loss provision which we recorded in the first quarter.

Five, finally the tax accounting associated with restructuring of certain our international operations and the resulting change in our tax rate in the first quarter and in subsequent quarters of 2009.

First, the progress on our tangible common equity improvement plan.

In the first quarter, we improved on our pro forma TCE ratio which assumes consolidation of our asset-backed commercial paper conduits from 1.19% at December 31, 2008 to 2.22% at March 31, 2009.

29 basis points of this improvement came from our organic capital generation, 15 basis points came from reduction in the size of our balance sheet, especially the size of earning assets, 30 basis points came from price improvement in the investment portfolio and asset-backed commercial paper conduits, 14 basis points net came from securities paying down or maturing in the investment portfolio, and another 7 basis points came from assets paying down or maturing in the asset-backed commercial paper conduits.

And lastly 8 basis points came from our dividend reduction.

We are moderately behind the improvement to our TCE ratio that we projected at our investor and analyst forum presentation primarily due to less improvement in pricing during the first first on our portfolio and conduits than was reflected in our plan.

We have revised our plan slightly for the remainder of the year, such that by the end of the second quarter we expect our pro forma TCE ratio to be about 3.16%, by the end of the third quarter to be about 3.94%, and to be about 4.57% by year end.

The details behind each of those quarterly goals are listed on slide 5 in the capital package which you can find on our Web site.

Next the changes in recording unrealized losses and the impact on State Street.

Given the timing of the FSPs, we elected to evaluate the impact during the second quarter and implement the FSP's on the effective date which is as of June 30, 2009.

We do not anticipate there will be significant impact on our earnings or our capital as a result of the adoption of the FSPs.

This is because we believe that the FASB in its announcement on FAS 157 defined the price at which the value of securities must be marked as the exit price, which is exactly the requirement of the current rule.

So in our view nothing changed.

As Ron indicated, the unrealized after tax mark on the investment portfolio improved by about $465 million, from approximately $6.3 billion at December 31, 2008 to approximately $5.9 billion at March 31, 2009, and by another $91 million as of April 17, last Friday.

The unrealized after tax mark-to-market loss in the conduits as of March 31, 2009 was $3.6 billion, about flat with December 31, 2008 and also flat with April 17, last Friday.

The after tax unrealized loss on the mortgage-backed securities increased while it declined a like amount on the asset-backed securities.

Regarding the PPIP, until further details of the program are known, such as the amount of leverage available to investors we are with not able to predict the impact that the program will have on valuations for different classes of assets.

We remain hopeful that the program will have a positive impact on the valuation of securities in our investment portfolio and conduits.

Right now we are focused on our TCE improvement plan which appears to be working as anticipated.

We noted in our press release this morning we recorded a provision for loan losses of $84 million to provide for the Company's revised estimate of future cash flows expected from certain commercial mortgage loans versus those expected at the time of acquisition of the loans which was in the fourth quarter of last year.

The provision reflects our view of the impact of deteriorating economic conditions on the commercial real estate market.

As has been widely publicized, the losses in the commercial real estate market have been significant and the loans we hold have been adversely impacted.

Our expectations of cash flows may change in the future depending on conditions in the commercial real estate markets.

We received net paydowns of $113 million and now carry these loans with the remaining net book value of $603 million over the dollar price of about $0.50 on the dollar.

We recorded income tax expense of $138 million for the first quarter of 2009 compared with $273 million for the first of 2008, with the decrease due to a lower level of pre-tax earnings and a lower effective tax rate.

The effective tax rate in the first quarter of 2009 is 22.5%, down from 34% in 2008, and is expected to be about 31.5% for the full year 2009.

Consistent with our business strategy, our intent to reinvest the earnings in certain of our non-U.S.

subsidiaries overseas allowed us to reduce taxes accrued with respect to 2009 earnings as well as certain taxes accrued in prior periods by $63 million.

This morning all of my comments will be based on our operating basis results as defined in today's press release.

As Ron mentioned, servicing and management fees actually performed well, particularly in light of the more than 40% decline on average in market valuations on both the S&P and the EAFE comparing the first quarter of 2009 with the first quarter of 2008.

Clearly securities finance and trading services revenue were weaker especially when compared with the very strong 2008 where both businesses exhibited unusual growth.

Compared to the first quarter of 2008, securities finance revenue declined 40%, and compared to fourth quarter it declined 45%.

This was due to lower demand offset by slightly improved spreads as well as our conservative investment management including shorter-dated assets to increase liquidity in our funds.

At quarter end, we had $363 billion of securities on loan, up from $347 billion at December 31, 2008.

The balance of securities on loan had improved from March 31, 2009 to about $415 billion as of last Friday, April 17.

About 10 additional customers have suspended participation in our program since our last disclosure and about eight have returned to our program.

In addition, we have added several new customers.

So all in, the number of customers in our program is about flat with our disclosure in the fourth quarter.

Average lendable assets for the first quarter of 2009 were $1.7 trillion, down about 40% from $2.8 trillion in the first quarter of 2008, in line with market declines as measured by the S&P 500 or the MSCI EAFE fund.

The duration of the securities finance book is approximately 21 days.

Foreign exchange was weaker due to a slowing cross-border investing as well as the result of financial weakness globally.

Trading slowed as well due to partly to declines in equity valuations.

During the quarter, however, we added new customers which are just beginning to affect revenue.

Our brokerage and other fee revenue was also impacted by losses in the trading account due to the performance of several of the bonds that we acquired in 2008 as well as a decrease in revenue from transition management.

I should note we do not manage a proprietary trading desk.

These bonds were one-offs that we acquired and we intend to sell as soon as practical.

Now for the remaining items in the income statement.

The decline in processing and other fees on a sequential quarter basis was primarily due to decreases in product related revenue.

Of particular note are the lower fees from the asset-backed commercial paper program where fees from this program decreased from $28.5 million in the fourth quarter of 2008, to $23.8 million in the first quarter of 2009, due primarily to higher commercial paper funding costs.

[Managers] revenue on an operating basis declined about 9% from the first quarter 2008 and about 27% from the fourth quarter of 2008.

The decline from the first quarter of 2008 was primarily due to a decline in customer deposit volume and spreads partially offset by lower interest rates worldwide.

The decline compared to the fourth quarter of 2008 was due primarily to the decline in LIBOR rates after year end and narrower spreads in both the investment portfolio and on customer deposits.

Net interest margin of 203 basis points was down 25 basis points from the fourth quarter 2008 on an operating basis.

Regarding operating basis expenses, a 26% decrease in first quarter expenses compared to the first quarter of 2008 and a 16% decrease from the fourth quarter of 2008, I will comment on only two areas.

First, salaries and benefits expenses declined 31% from the first quarter of 2008, due primarily to a reduction in incentive compensation in the first quarter of 2009, as well as our reduction in force which is now completed.

Salaries and benefits increased 5% compared to the fourth quarter which included a significant reduction in 2008 incentive compensation, all of which was recorded in the fourth quarter of 2008.

This change relative to the fourth quarter was partially offset by the impact of the headcount reduction which we just completed.

Other expenses also declined significantly in the first quarter of 2009, down about 45% from the first quarter of last year and down 64% from the fourth quarter of 2008.

These declines were due primarily to reduced securities processing costs and a reduction in professional fees and we plan on continuing to be vigilant in managing these expenses.

Now let me turn to the investment portfolio.

The size of the average investment portfolio at March 31, 2009 has declined about $3 billion since the first quarter of 2008.

As you may recall, as of November 7, 2008, we transferred most of our non-agency mortgage-backed securities and our commercial mortgage-backed securities portfolios to our hold-to-maturity portfolio so neither has negatively impacted our OCI any further this quarter.

The unrealized losses on each of these reflect declining housing and real estate valuations.

So while the unrealized after tax losses on our available-for-sale and our hold-to-maturity portfolio improved about $465 million, the improvement in the other comprehensive income was about $665 million.

In our investment portfolio slide presentation we have updated the data through quarter end for your to review.

As of March 31, 2009, our portfolio is 84.3% rated AAA or AA; 73.1%, AAA and 11.2% AA rated.

We have had no defaults in these assets and all are current as to principal and interest.

The duration of the investment portfolio is very low at 1.3 years, the result of our conservative reinvestment plan.

At the same time, we are not in the corporate or consumer lending business.

The majority of the loans on our balance sheet are customer overdrafts, mostly overnight and are not subject to the types of credit risk associated with commercial or mortgage lending.

In the second half of 2008, our balance sheet had been much larger than normal due to increased liquidity from our customer deposits in the recent market environment and our participation in the Fed's AMLF facility.

However, in the first quarter customer deposits reverted back to pre-Lehman bankruptcy levels and our excess liquidity was about $23.7 billion at March 31, down $18.6 billion from year end.

As of March 31, 2009, we left about $30 billion in excess balances with central banks, down from $52 billion at the end of 2008.

Next, a further discussion on the 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 in the asset-backed commercial paper slide presentation which you will find on our Web site.

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

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

As of March 31, 2009 the conduits held assets of $22.5 billion, down from $23.9 billion on December 31, 2008, due to asset amortization and the strengthening of the U.S.

dollar.

65% of the assets are rated AAA, AA, or A compared to an average computed by Moody's of 53 banks of 29% as of December 31, 2008.

None of the assets in our conduits are subprime nor are there any structured investment vehicles in the conduit program.

However, during the first quarter of 2009 the conduits continued to experience more downgrades principally affecting about 66 securities in the U.S., RMBS and HELOC asset classes.

These securities were downgraded in some cases from AAA to below investment grade.

As of March 31, 2009, the assets continue to have a weighted average maturity of about four years, and all securities in the conduits are current as to principal and interest.

The commercial paper market continues to be considerably strained particularly since the end of the third quarter of 2008.

As a result, we utilized the CPFF program to prudently manage our liquidity position.

As of March 31, 2009, our conduits sold in an additional $3 billion in commercial paper to the CPFF program for a total of $8.5 billion sold to that program as of March 31, 2009.

Since those assets are sold for a period of 90 days, our weighted average maturity on the commercial paper extended to 31 days.

As of March 31, 2009 we held $4.7 billion of our commercial paper on our balance sheet.

As of last Friday, April 17, several large customers have returned to our program and that amount had declined by $3.2 billion to $1.5 billion as markets became more active in early April after quarter end.

You might ask why the conduits didn't sell additional paper to the CPFF.

A number of factors determine whether the conduits will utilize the CPFF including our management of liquidity, the cost associated with each funding source, as well as the conduits' desire to maintain sufficient paper to sell to customers.

Remember any paper sold to the CPFF must be sold for 90 days.

Let me now make a few brief remarks on our outlook for our net interest margin in 2009.

First of all, 2008 was an anomalous year with unusually strong growth in net interest revenue and atypical net interest margin expansion.

In 2009, we assume that we will continue to delay investments in the investment portfolio in order to meet the goals of our TCE improvement plan.

As of March 31, 2009, we have about $13 billion in assets maturing or paying down in the remaining three quarters of 2009 which are currently priced at a dollar price of $84 on average.

In the second quarter, we expect to continue to limit reinvestments and deposit most of the cash from maturing or paying down assets with central banks.

Later in the year, we will proceed cautiously with a conservative reinvestment strategy consistent with the goals of our plan.

We expect interest earning assets to decline relatively modestly over the remainder of 2009.

We continue to expect the net interest margin to be between 170 and 180 basis points on average for the year excluding the impact of the AMLF in 2008 and 2009, and in 2008 also excluding the SILO adjustments, the net interest revenue.

The Bank of England recently reduced its overnight rate to 50 basis points and we expect it to remain there for the rest of the year.

The ECB recently cut its overnight rate to 1.25% and we expect it to remain there throughout the rest of the year.

And finally, we expected the Fed to keep the overnight Fed funds rate at 25 basis points for all of 2009.

In conclusion, despite a decline in revenue due primarily to a weakness in the equity and fixed income markets we performed well in the first quarter.

The conduits remain unconsolidated, their assets continue to decline and the unrealized loss has stabilized compared to year end.

Although we have not suffered any losses from the conduit assets, that program continues to experience heightened stress due to downgrades of the non-agency U.S.

RMBS assets and several of the RAP providers.

We essentially expect to gain little benefit from the FAS 157 announcement this quarter.

However, we did see some improvement at March 31, 2009, and again at April 17, in the unrealized losses of the investment portfolio.

As we've noted previously, we expect our net interest margin for 2009 to be between 170 and 180 basis points.

We maintained good expense control this quarter and expect that to continue throughout the year.

We made progress on our TCE improvement plan and expect to return to our pro forma TCE ratio to be in line and our 4.25% to 4.75% target range by year end.

Now I'll turn the call back to Ron.

Thank you, Ed.

So where do we stand?

While signs of improvement are beginning to appear, we are still being cautious about the outlook for this year as many uncertainties remain as reflected in our updated outlook.

To address the uncertainties, we are focused on the factors we can control.

The steps that we announced in the fourth quarter to reduce expenses have positioned us more favorably for 2009 and for a return to more normalized markets.

At the same time, we've maintained our capacity to add new business, being positioned to benefit from increased business as markets improve, and we execute upon our marketing goals.

In addition in the first quarter, we controlled expenses and achieved significant positive operating leverage compared to the first quarter of 2008.

Our servicing and management fee revenue, while down from the previous year's first quarter and record fourth quarter, compared favorably to the declines in the S&P 500 and the MSCI EAFE index.

We continue to believe that this period is one in which we have opportunities to build market share.

Our TCE improvement plan is progressing and has resulted in demonstrable improvement in our ratio.

Prepayments were a little lower than our assumptions, but overall we improved the adjusted pro forma TCE by 103 basis points and have set a target of over 4.5% for year end, within our long range target for a TCE ratio of 4.25% to 4.75%.

While we, like others in our industry, expect operating results in 2009 to decline from 2008, in our case from record levels in 2008, I want to emphasize that our core business is strong and that we are well positioned for continued growth within our long-term goal ranges upon a market recovery.

We are beginning to see brightening signs, but we have a way to go before government programs and other market forces take full effect and investors step back into the markets in a significant way.

Until then we will continue to be vigilant in calibrating our expenses to align with the market environment while ensuring we continue to invest in solutions for our customers who are increasingly looking to us for a broader range of services.

With that, I will, Ed and I are very happy to take any of your questions at this time.

(Operator Instructions) We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Brian Foran with Goldman Sachs.

Good morning, guys, how are you?

Hi, good, Brian.

How are you?

I guess, first, to start and I apologize if you said this earlier, I joined late.

But JPMorgan for their TSS business assuming a flat equity market was actually guiding to the rest of the year, run rate revenue being higher than it was in the first quarter.

Given what you are seeing do you share that view?

I can't compare to what JPMorgan Chase is doing.

If my memory serves me well they have other sources of income in that, things like corporate cash management things.

I don't think it's a good comparison.

And, I guess, maybe ask it a little differently relative to Bank of New York, because they were also making comments that some of the deleveraging in the securities lending business was probably behind us at this point.

When we look at your securities lending business, do you feel like we are fully through the deleveraging process and what we are seeing now is kind of a baseline revenue run rate we can forecast out or do you think there's still some deleveraging in that book to go?

You saw the volume numbers that we gave pretty much flattened out and actually increased from the end of the quarter to recently.

From a volume point of view I'd say things have pretty much bottomed out.

Lastly, if I could, other banks that seem at a high level to have somewhat similar levels of risk in the securities book are taking pretty big OTTI charges the past couple of quarters including this one.

When you look out over the rest of the year and kind of embedded within your guidance, is there any OTTI assumption included in the guidance, and as we think about just reported earnings rather than operating earnings should we expect any meaningful OTTIs as we look out through the rest of the year?

Yes, Brian.

This is Ed.

We don't include any expected OTTI in any of the guidance we give.

If we have any, we consider it operating as we have in the past, as we did in 2008.

And we can't predict the future, obviously, but OTTI and the determination we made under the newly issued FSP in the second quarter, OTTI is something we evaluate every quarter.

We go through a process, we identify candidates that are possible candidates and then we do a detailed cash flow analysis on each of the securities and make a determination.

Thank you.

Your next question comes from the line of Michael Mayo with CLSA.

Good morning.

Hi, Mike.

I wanted to understand more the expense levers that you have and make sure I'm reading you correctly.

You are shrinking the balance sheet, you expect the margin to go down, soft revenues continue, that should'nt be a surprise.

So I guess my question is, what percent of your expenses are fixed versus variable and how much more in levers do you have now that the Investors Financial savings are far along?

I think, as Ed said, we finished our reduction in force, about 2,200 people, but I think importantly, as I said, we realigned our infrastructure.

So I think we are at a point where with we have a pretty efficient operating infrastructure.

I don't anticipate any more reductions there, but we seem to have quite a bit of room, anyways.

When you think about the significant reduction in revenue and the ability to generate positive operating leverage, I think we have some capacity there for the future.

And with regard to revenues, the non-U.S.

story has been a bright spot.

I'm wondering if that's now more of a relative negative.

To the extent that Europe might be a few months behind the U.S., what are you seeing U.S.

versus non-U.S.

in terms of revenues?

Actually, U.S.

is picking up.

We've got, I think, we as we said on the investor day, a lot of discussions in the U.S.

in terms of outsourcing the complete operations of U.S.

fund managers and hedge managers as well.

That's continuing and there is also, when you look at that kind of business there is a U.S., non-U.S.

component to it, and I think we are somewhat uniquely positioned to be able to satisfy those kind of requirements in different jurisdictions.

So the pipeline continues to be full.

The pipeline, is the change in the pipeline, better or worse or the same, non-U.S.

versus U.S.?

I would say U.S.

has picked up.

Non-U.S.

has always been pretty strong.

The one thing I would say is the decision making takes a lot longer in some of these deals because they are bigger deals.

There is a lot of activity, in the first quarter we sold a lot of business.

But the decision making takes some time.

The realization of that revenue is slower right now.

And then last follow up, is that slower decision making what you saw back in 2000, are we going through that kind of cycle again?

That's interesting.

It could be.

Yes, we probably are a little bit.

Okay, all right.

Thank you.

Your next question comes from the line of Howard Chen with Credit Suisse.

Good morning, Ron and Ed.

Hi, Howard.

Thank you for taking my question.

Ron, apologies if I missed this in your prepared remarks, but can you you discuss your latest thoughts on the TARP program and potential payback there?

No, we didn't talk about it.

We, like everybody else, I'm sure would like to pay back the TARP money, but there is a process we all have to go through, and we will go through that process like everybody else.

At the appropriate time we will make those decisions, that's probably the only thing I can say about that.

Okay, thanks.

And then, Ed, thanks for the detail on the revised TCE improvement plan assumptions.

Looking at the changes from the February analyst day, there isn't much change in your prospects for organic capital generation, particularly in the back half of the year.

So coming off a weaker than expected revenue quarter does the revised plan assumption assume you anticipate a material revenue rebound in the second half and what do you think drives that, or am I missing something, another offset?

The TCE improvement plan is predicated on the guidance that we gave, which is towards the weaker end of the ranges that we put forth.

Both of them are totally in sync, Howard.

Okay.

Thanks.

Finally for me, with respect to securities lending business in particular, in recent quarters you guys have been helpful in discussing that the lower volumes being somewhat offset by the richer spreads, could you give us some of your latest thoughts and color around that business in particular?

Well, the volumes have come in, did come in, in the fourth quarter.

They have rebounded somewhat in the first quarter, but they are still below the very robust volumes that we had going back a couple of quarters.

But the spread environment has improved.

And to overall market, which has been that the rates have come down a bit, spreads come down a bit, which has not been a positive driver to the earnings results of the securities lending business particularly.

Okay.

Maybe just to follow up on that, Ed, any kind of, I guess, specifics that you can provide, not to get so near-term oriented, but if I thought about the fourth quarter environment versus what you saw in the March quarter any sense of the magnitude of spread compression within that business?

Let me get a page.

Okay.

In the average spread for the entire program, Howard, just to put it in some numbers, first quarter was about 84 basis points.

In the fourth quarter of last year it was 137 basis points.

Okay.

Great, that's really helpful, thanks a lot.

Sure.

(Operator Instructions) Your next question comes from the line of Nancy Bush with NAB Research.

Good morning.

Hi, Nancy.

Ron, I guess I'm still missing something here in sort of getting to the final shape of the Company after TCE improvement.

How big do you want to investment portfolio to be in, as a percentage of assets are the conduits going to be eliminated or downsized to some kind of minimal size?

If you could just give us sort of preview of sort of the shape of the Company to come?

Sure.

Let me talk about the conduits first.

Similar to what we said in the past, I think, we definitely want to downsize the conduits.

I think I've said in the past we want to make it at least half of what it once was, but I think the important metric is to look at the conduits with respect to how much capital we have.

And I think we have to look at it that way.

We are going to be doing that going forward.

We're going to continually look to bring those conduits down.

With the investment portfolio we don't make loans.

We invest in securities.

So that's -- in today's environment that's probably a pretty good place to be.

We are going to continue to have probably a sizeable investment portfolio.

We will look to see the content of that investment portfolio going forward.

But it's clear to us that we are going to live in a much more highly regulated deleveraged world.

We will have to look at that.

But that's the nature of our business.

I guess that's about what I could say about that.

Are there other places in the Company that you would be looking to "de-risk?" Are there places in SSgA, either there products or whatever, volatility of products.

I guess I'm just trying to get to the risk, the ultimate risk profile of the Company.

Yes.

Well, I think we have done a pretty good job putting the risk structure in place.

I think we identified where all the risks are.

Generally speaking what I would say is that traditionally what you see in a lot of banks is where you find the risks there in some of the smaller businesses that you may not put a lot of focus on.

We've done that.

There are a number of smaller businesses that we looked where the risk/reward ratio may not be what we want it to be.

We will take a look at those things and restructure if necessary.

In terms of the major pieces of business, I think we got a pretty good handle on the risks associated with those businesses.

If you look back at our history, and probably the history of others, it's those smaller businesses that end up with a different kind of risk/reward ratio.

We spent a lot of time looking at those businesses and looking at the risk/reward ratio of those businesses and we'll make decisions going forward based on that.

Thank you.

Your next question comes from the line of Ken Usdin with Banc of America Securities-Merrill Lynch.

Thanks.

Good morning.

Just one question on the guidance, again.

I was just wondering, you mentioned that, obviously, there are a couple of of pieces of the revenue environment that are weaker, and you did indicate that the tax rate would be lower throughout the year.

So, Ed, I was wondering, could you give us a little bit more detail on -- if the tax rate is a net benefit perhaps and keeps you in that guidance range, specifically, outside of the market levels which are more obvious, what areas of the business are you expecting to be a little tougher relative to your prior expectations on the top line perspective?

I don't think there is any particular area, Ken, that we expect to be tougher over and above what we said on February 5.

We expect the foreign exchange, securities lending and management revenue performance to be about in line with what we said previously.

A lot of that, and certainly in [NIRs] is driven by the TCE improvement plan.

There is not any one thing per se to point to in terms of change revenue expectation.

We still expect 2009 to be a challenging year on the top line across the board.

And within that, would you say, is there any change fundamentally to -- second quarter is typically a, historically, has been a seasonally strong area in terms of foreign exchange and [sec] lending most specifically, has anything changed with regard to the deleveraging environment or activity that would deem that not to be the case, this second quarter as far as seasonality is concerned?

No, we don't foresee anything that is unique relative to this second quarter as opposed to some others.

Just the general environment which is lower volumes we do see relative to the environment.

Right.

Okay.

Great.

Then the last question just on the TCE rebuild plan, just to clarify, in the 457 that you are expecting from year end that does not assume any improvement from here as far as unrealized?

(inaudible) Correct.

That's what I mean.

There is nothing baked into that 457 by year end, that is based on directional change in either the portfolio or the conduit?

Nope.

The same assumptions we made on February 5, Ken.

Right.

Okay.

Got it.

Thanks a lot.

Your next question comes from the line of Vivek Juneja with JPMorgan.

Hi, Ed.

Hi, Ron.

A couple of questions, firstly, asset management, can you talk a little bit about when you look at what you are seeing in terms of outflows versus inflows this quarter?

Your passive assets were down about 8%, could you comment on what -- how much of that was market driven versus business flows, or volume flows?

Most of it was market driven, as I think we said.

We enjoyed some net new business, the ETF business continues to be strong.

There was no one thing that I could point to that would make a big difference.

The next one is probably appropriate for Ed.

Other expenses, what's a good run rate for that, Ed, as we look out given that was down so sharply this quarter?

How should we think about it for the rest of the year?

Well, I think we should, I think you should think about it as being up a bit from this quarter where we enjoyed a pretty significant benefit, certainly sequentially.

In terms of the full year, I think that that line, you should be thinking about probably in terms of about a 15% or so decline over last year's full year number.

Okay.

That's great.

And, lastly, one other little thing, with the CP conduit noticed that there was a lot more of the CP back on balance sheet at March 31.

Any reason why that's come back on balance sheet as opposed to tapping the Treasury?

Well, we saw some customers back away a bit from the asset class.

Not just necessarily our program, but we believe the asset class more broadly in the first quarter.

So we saw some more come on the balance sheet in general.

The decision whether or not to put any CP that we get on our balance sheet into the CPFF is a function of our own liquidity and the cost associated with putting it in the CPFF for the 90-day term.

In addition, we've seen some customers subsequent to the end of the quarter, Vivek, come back into the asset class and we've seen some improvement there for the first couple of weeks of the second quarter.

So we try to strike a balance between the liquidity needs, the cost and the amount of paper that we want to have available to sell to customers and that's the decision we made at the end of the quarter.

Okay, great.

Thank you

Your next question comes from the line of Greg Ketron with Citigroup.

Good morning, thanks for taking my questions.

Good morning.

Question on the conduits, you had about, it looks like about $1.4 billion reduction in size.

Can you comment on how much of that was cash flow or if there were any conduit assets that were added to the balance sheet?

It was all cash flow and strengthening of the dollar.

There were no conduit assets added to the balance sheet.

Okay.

Would it be fair, in the past you mentioned that maybe $1.2 billion to $1.5 billion reduction in size expectation for the conduits, does that continue to be reasonable assumption going forward?

It's about $1 billion a quarter, Greg.

Okay.

Billion dollars.

Okay.

And then on the credit, you had mentioned the provision that you took was related to the commercial real estate portfolio, which I believe it was around $800 million.

That's correct.

And is there anything else, I know most of your lending is related to securities activities, but is there anything else in the credit portfolio that we should look for or that concerns you going forward?

No.

I mean, the commercial real estate loans are an isolated position that we have that we took on in the fourth quarter of last year.

As we said, we don't as a matter of course lend per se in that marketplace.

So clearly those loans are things we are focused on and looking at but nothing else.

Okay.

Great, thank you.

Your next question comes from the line of Thomas McCrohan with Janney Montgomery Scott.

Hi, good morning.

Could you give us an idea of how much of your earning assets are in liquid -- highly liquid securities?

BK, this morning, disclosed that they shifted a lot of their assets on their balance sheet into really safe securities.

I'm just trying to make a comparison.

Okay.

We have been putting a lot of excess liquidity, as we've noted, Tom, into our central bank accounts over the last several quarters.

That's probably been the main structural shift, if I can call it that, that we've made over the last several quarters.

We have not -- and that balance has, obviously, decreased from December to now as I noted in my comments, I think from $52 billion down to about $30 billion.

That's a function of customer deposits being put back to work by our customers which we think is is a good thing.

We have not made any conscious structural shifts to move any elements of the portfolio into some "safer" securities, whether it's treasuries or agency mortgage-backed.

I would say from our standpoint it's the central bank balances that would be the thing you should focus on to do the comparison you want to try to draw.

Okay.

And shifting to the outsourcing trend, it sounds like there's a pick up in activity surrounding outsourcing, which is something we haven't heard about for some time with the big kind of discussion item a few years ago, now it sounds like something is changing in the market.

Maybe you can just talk a little bit more about what is going on in the hedge fund space, I think you pointed to that in particular as being more right for outsourcing opportunities.

Yes, Tom.

In the hedge funds space, there is a keener desire for hedge funds to outsource their administrative functions for a number of reasons.

Obviously, the cost pressures, two, the fact that you have an independent third party doing these things, last time I think we called it the Madoff effect.

And that's pretty intense, and that's continuing and we have a pretty robust platform to do that through our purchase of IFS three or four years ago.

So that's enjoying a lot of discussion.

And then the traditional outsourcing of investment management back offices has, I think, enjoyed a resurgence, and when I say that, a resurgence in terms of discussion, not necessarily sold deals, but there's a lot of discussion about the outsourcing of much larger investment management organizations.

People are looking at it.

We haven't seen a lot of closed deals.

I think as I said in a previous -- in answer to a previous question, the sales cycle is a lot longer because these are big decisions.

But there's a lot more discussion about doing that for the obvious reasons of trying to turn a fixed cost into a variable cost, reduce the cost of future expense and the allocation of capital has become do dear now and the investment management companies need to allocate that towards investment performance and distribution.

So there's a much greater desire to reduce the percentage of capital directed towards administration and I think over the longer period of time we will become the beneficiary of that.

Ron, do you see anything on the regulatory side that would kind of accelerate that process?

Obviously, some of this --

Oh, yes.

Oh, yes.

We see it every day.

It's clear to us there is going to be a much higher regulatory burden on any type of investment management organization.

We have not necessarily seen that translated yet into rules and regulations which will then translate into products, but it's beginning to happen.

So you'll see that in the intermediate and longer term and those that have fairly robust accounting and administrative capabilities, I think, will take advantage of that.

But that's going to come, and I think it's going to come when it does very quickly with a lot of regulatory burden and, again, another reason why these organizations want to eliminate that expense.

If they can avoid that, they are going to.

Thank you.

At this time, there are no further listener questions.

I would like to turn the call back over to management for closing remarks.

Don't have a lot of closing remarks, I just want to remind you that I think that what we have done is position the Company to take advantage of growth opportunities that will emerge.

We've built, I think, a very efficient processing platform given what we have done in the last two quarters and we are going to take advantage of it, and I think you will see that going forward.

So with that, I'd just say thank you, and we will talk again soon.

Ladies and gentlemen, this does conclude today's State Street Corporation's first quarter call and webcast.

Thank you for your participation.

You may now disconnect