道富銀行 (STT) 2010 Q2 法說會逐字稿

Good morning and welcome to State Street Corporation's second-quarter 2010 call and webcast.

Today's discussion is being broadcast live on State Street's website 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 website.

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

(Operator Instructions).

Now I'd like to introduce Kelley MacDonald, Senior Vice President for Investor Relations at State Street.

Before Jay Hooley, our President and Chief Executive Officer, and Chief Financial Officer, Ed Resch, begin their remarks, I'd like to remind you that 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 2009 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, July 20, 2010, 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 a slide presentation regarding the Corporation's investment portfolio, as well as our second-quarter earnings press release, which includes reconciliations of non-GAAP measures referred to on this webcast, in the investor relations portion of our website as referenced in our press release this morning.

Jay?

Thanks, Kelley, and good morning.

In the second quarter we continued to experience momentum in our servicing fee revenue and also saw good growth in our trading services revenue.

Additionally, the impact from the Intesa and Mourant acquisitions which closed during the quarter supported our strong results.

I'll make a few comments about our performance and then I'll ask Ed to provide a more detailed financial perspective, and after that we'll open up the call to your questions.

Operating basis earnings per share were $0.93, up 4% from a year ago quarter and up 24% from the first quarter.

On an operating basis, comparing the results of the second quarter with the first quarter of 2010, total revenue increased 2.2% and total expenses declined 6.3%.

As a result we achieved 850 basis points of positive operating leverage.

Our service fee revenue increased 20% from the second quarter of last year and was up 9% from the first quarter of this year, reflecting the impact of the installations of last year's large wins as well as new business in the first half of 2010.

We just completed installing the large Morgan Stanley mandate which (technical difficulty) fully in the run rate for the third quarter and we're just now converting the state of New Jersey and will convert the state of Ohio near the end of the third quarter.

We added $1.1 trillion of new servicing mandates in the second quarter, including the two acquisitions, and have active new business pipelines with a particular emphasis outside of the US and in our alternative servicing area.

The acquisitions of Intesa Sanpaolo Securities Services business and Mourant International Finance Administration are on track to meet our expectations for the year and contributed modestly to the quarter, excluding the merger and integration costs.

I remind you that Intesa was only part of State Street for the second half of this quarter.

The Intesa integration is proceeding as planned; we've already met or talked with most of the major clients and have held town hall meetings with our new staff.

We're pleased to be working for an organization that is focused on and intending to continue to invest in the business.

The performance of our asset management business is (technical difficulty) in line with the worldwide equity markets as measured by an average of the three month end values.

Trading services revenue in the quarter performed very well, helped by increased volatility in foreign exchange markets as well as continued growth in electronic trading and transition management.

The sequential quarter increase in securities finance revenue was principally due to the impact of the dividend season in Europe.

As we disclosed on July 7, we made a one-time cash contribution to the SSgA lending fund which restored the market-based net asset values to $1 per unit in those funds as of June 30, 2010, enabling us to remove redemption restrictions from those clients in mid August and also mitigating potential liabilities.

We also expect to address client access to liquidity in the agency lending program by year-end by separating the agency lending collateral pools into two parts, one with complete liquidity and no redemption restrictions and the other comprised of longer dated assets with continued restrictions on redemptions.

We believe both of these actions support our commitment to resolving the challenges that remain as a result of the market turmoil over the past several years.

As mentioned, we closed two acquisitions this quarter and continued to maintain strong capital ratios as evidenced by our Tier 1 risk-based capital of 15.1%, our Tier 1 leverage ratio of 7.7%, and our tangible common equity ratio of 6.3%.

Regarding the financial reform legislation recently passed by Congress, at the outset I would say that we don't believe the focus of this legislation was aimed at the activities of the trust and custody banks.

And our initial read of the 2,300 page piece of legislation is that it will not have a material affect on our business model and may in fact provide additional servicing opportunities.

Turning to new business -- in the second quarter of 2010 we have $1.1 trillion in assets to be serviced including $686 billion from the two acquisitions.

Among the many encouraging themes I see in the new business pipeline, the servicing for alternative asset management remains a highlight.

This quarter following the acquisition of Mourant on April 1 we added 10 new clients.

As of June 30, 2010 including the Mourant acquisition our assets serviced and alternative investments have grown to approximately $620 billion from the $440 billion at year-end 2010.

In the broader investment servicing business we continue to see strong growth.

A few of the highlights are as follows -- State Street was appointed to provide global custody, fund accounting, compliance reporting services, foreign exchange and portfolio research and trading solutions to the Guotai NASDAQ 100 Index Fund, the first fund in China to track the performance of an overseas index.

We've been selected to provide a range of hedge fund administration services for approximately $8 billion in assets managed by Anchorage Advisors.

We were also appointed to provide investment services to hedge fund group Marshall Wace for its new equity neutral exchange traded fund which is listed on the London Frankfurt Stock exchanges.

State Street received a mandate to service investments managed by Norges Bank for up to 5% of the government pension fund investing in real estate which is currently valued at around $20 billion.

London-based Strategic Investment Group has appointed State Street to provide custody fund administration and currency management services to its new Ucits III absolute return multi-manager fund.

And the Contra Costa County Employees Retirement Association of California has appointed us as a transition manager for a $4.3 billion fund.

State Street Global Advisors during the quarter also added new mandates including the appointment by [PVM Bante] to manage EUR50 billion in pension fund assets, an Italian public employee fund which has EUR380 billion in assets under management.

SSgA was selected as one of four investment managers for Alliance Bernstein's newly launched multi-manager retirement strategies, a target date solution fund.

We were also awarded three large passive equity tax aware mandates totaling AUD10 billion by QSuper, one of Australia's largest superannuation funds.

We won a passive core fixed income mandate for the Illinois State University's retirement (technical difficulty) System's fixed income portfolio.

The System has informed us that the mandate could range from $400 million to $700 million.

We've also been selected by [Pegasso] Pension Fund of Italy, a public pension scheme for employees of Italian gas and electric utilities to manage more than EUR60 million in active fixed income assets.

And lastly, SSgA was recently appointed as the beta management partner for San Diego County Employees Retirement System.

Now turning to expenses, in the current environment we're very focused on keeping tight control over all categories of expenses.

The decline in salaries and benefits expense compared to the first quarter is primarily due to the lower incentive compensation accrued in the quarter, a result of the charge related to securities lending.

Let me now share our view of the current economic outlook and the outlook for our business.

Although we continue to believe the economy in the US is improving, it is recovering at a slow protracted rate and is affected by uncertainty in Europe.

The market is forecasting real annualized GDP growth in the United States of 2.5% to 3% for each of the remaining quarters of 2010.

Economic growth is not enough -- not strong enough to drive meaningful gains in employment, credit is tight and the housing sector appears to have bottomed at (technical difficulty) levels but is very mixed by region.

Consumer spending has also been cautious.

The daily average of the S&P 500 as of June 30, 2010 is about 1,129 year to date and, as you recall, our outlook for this is based on 1,125 average for the year.

We are participating in this gradual recovery, especially as seen in the continued momentum in servicing fees.

We continue to expect to see growth in fee revenue and expect that with the gradual recovery the market driven revenue will improve slightly towards the end of the year.

I'll now turn the call over to Ed who will provide further detail about our financial performance in the second quarter and I'll return to provide several (technical difficulty) reflecting our outlook for the remainder of 2010, and then we'll open the call up for questions.

Ed?

Thank you, Jay, and good morning, everyone.

This morning I'll (technical difficulty) three areas.

First, the results of the second quarter; second the improvement in the unrealized losses in the investment portfolio and the overall performance of the portfolio, as well as our outlook for (technical difficulty) margin in 2010; and third a review of our strong capital position.

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

Comparing the second quarter of 2010 with the second quarter of 2009, service (technical difficulty) revenue (technical difficulty) 20% (technical difficulty) average equity (technical difficulty) valuations and the (technical difficulty) of our two acquisitions.

Management fee revenue was up 12% primarily due to (technical difficulty) increase in equity (technical difficulty) valuations (technical difficulty) as well as new business wins.

Compared to the first quarter our servicing fee revenue increased by 9%, trading services revenue by 35%, securities finance revenue by 51%, and operating basis net interest revenue was up 7%.

Providing further details on the trading services and securities finance revenue -- foreign exchange revenue declined 3% compared to the second quarter of 2009 due to lower volatility offset partially by higher volumes.

Compared to the first quarter of 2010 foreign exchange revenue increased 38% due to both higher volatility and higher volumes.

Brokerage and other revenue, which is reported as part of trading services, increased 18% compared to the second quarter of 2009 and was up 31% compared to the first quarter of 2010 with both increases primarily due to higher revenue from electronic trading transition management.

We averaged $421 billion of securities on loan in the second quarter of 2010 compared with $418 billion in the second quarter of 2009 and $412 billion for the first quarter of this year.

The improvement in securities finance revenue compared to the first quarter was primarily due to the impact of the dividend season and also benefited from the increase in the average spread between Fed funds and three-month LIBOR.

This average spread widened to 24 basis points in the second quarter of 2010 from an average of 12 basis points in the first quarter.

Compared to the second quarter of 2009, which also was favorably impacted by the dividend season, revenue declined due to compression in average spreads from a year ago when the average spread between Fed funds and three-month LIBOR was approximately 67 basis points.

Average lendable assets for the second quarter of 2010 were about $2.2 trillion, down slightly from $2.3 trillion in the first quarter of 2010 and up about 16% from $1.9 trillion in the second quarter of 2009.

As of June 30, 2010 the duration of the securities finance book was approximately 17 days, down from 21 days in the first quarter of 2010 and down from 25 days in the second quarter of 2009.

Now for the remaining items in the income statement.

Compared to the first quarter of 2010 processing and other fee revenue of $87 million decreased 28% or about $33 million due primarily to the impact of the $30 million gain on the buyout of a legacy leasing transaction in the first quarter and was up significantly from the second quarter of 2009 due to the impact of higher fees from structured products, tax advantage investments and other fees in the second quarter of 2010.

Operating basis net interest revenue increased about (technical difficulty) from the second quarter of 2009 due to the impact of adding the Intesa deposits and a modest decrease in our funding costs.

Operating basis net interest revenue was up 7% from the first quarter of 2010 primarily due to favorable yields on our investment portfolio, the steeper short end of the yield curve and the impact of the Intesa deposits.

Operating basis net interest margin of 166 basis points, which excludes discount accretion, was up 9 basis points from the second quarter of 2009 and was up 4 basis points from the first quarter of 2010.

Including discount accretion of $172 million in the second quarter of 2010, $212 million of the first quarter of 2010, and $112 million in the second quarter of 2009, net interest margin was 221 basis points compared to 234 basis points and 193 basis points respectively.

In the second quarter of 2010 we recorded about $3 million in net gains from sales of available for sale securities and separately about $53 million of OTTI resulting in (technical difficulty) $50 million net loss related to investment securities.

The OTTI was primarily due to increases in expected future credit losses on US non-agency mortgage-backed securities.

To recap where we are relative to future discount accretion, as of March 31, 2010 we expected about $4.1 billion to accrete into interest income over the remaining lives of the assets.

And so now, deducting the $172 million of discount accretion we recorded in the second quarter of 2010, we now expect about $3.9 billion.

We continue to believe that $850 million will not accrete into net interest revenue due to credit.

There has been no change in our view relative to credit.

Based on the slowing in (technical difficulty) speeds we now expect about $750 million to accrete into income in 2010, $550 million in 2011 compared to the $800 million and $600 million respectively that I mentioned on the first-quarter conference call.

As you are undoubtedly aware, a significant number of assumptions go into the estimate of future discount accretion, including estimated prepayments, expected future credit losses across various asset classes, sales to date and an assumption that the securities are held to maturity.

Regarding operating basis expenses, second-quarter expenses increased 9% compared to the second quarter of 2009 due primarily to increases in salaries and benefits offset partially by a decline in other expenses.

The 19% increase in salaries and benefits expenses was due primarily to the accrual for incentive compensation in the second quarter of 2010 as well as the impact of our acquisitions.

There was no discretionary cash incentive compensation accrued in the second quarter of 2009 in order to support our tangible common equity improvement plan.

Of course the accrual of incentive compensation is subject to company performance.

Other expenses declined 16% from the second quarter of 2009 primarily due to lower securities processing costs and an $11 million recovery associated with Lehman Brothers.

Expenses in the second quarter of 2010 declined 6.3% from the first quarter of 2010 due to both a decline in salaries and benefits as well as a decline in other expenses.

Salaries and benefits expense increased 6% for the first quarter of 2010 primarily to the impact on the incentive compensation accrual of the charge recorded in the second quarter related to the securities lending program as well as the impact of first-quarter equity awards made to retirement eligible employees, offset partially by the increases due to the acquisitions as well as merit and promotion awards.

Other expenses declined 24% from the (technical difficulty) quarter 2010 due to lower securities processing costs and an $11 million recovery related to Lehman Brothers.

Transaction processing expenses increased $18 million or 12% compared to the second quarter of 2009 and were up 7% from the first quarter of 2010, both increases due to higher volumes in asset servicing including the impact of the two acquisitions.

No other item in operating expenses increased or declined meaningfully either on a sequential quarter or year-over-year basis.

Our negative data GAAP tax rate of 23.1% in the second quarter was the result of a one-time tax benefit generated by our restructuring of non-(technical difficulty) former conduit assets.

In addition to some regulatory benefits the restructuring triggered a current tax deduction for losses that were recognized for accounting purposes at the time of the 2009 conduit consolidation.

Our operating tax rate, which excludes this GAAP adjustment, is (technical difficulty), in line (technical difficulty) outlook (technical difficulty) call and down from 31.5% in the second quarter of 2009 due to a change in the geographic (technical difficulty) of our earnings.

Now let me turn to the investment portfolio.

The average balance in our investment portfolio in the second quarter increased about $19.8 billion (technical difficulty) .3 billion compared to the second quarter of 2009.

This increase is primarily to the consolidation of the conduit assets (technical difficulty) fair value then (technical difficulty) .6 billion, as well as the continuing execution of our reinvestment strategy offset partially by maturities and sales of selected securities.

During the second quarter we invested about $9.8 billion in highly rated securities at an average price of (technical difficulty) and a quarter with an average yield of 2.98% and a duration of approximately 2.5 years.

Those $9.8 billion are primarily comprised of the following securities, 91% of which are AAA rated -- 5.

(technical difficulty) billion dollars in agency mortgage-backed securities; $0.2 billion in non-agency mortgage-backed securities; 2.8 (technical difficulty) million dollars in asset-backed securities including $0.8 billion in foreign RMBS mostly UK and Dutch issues and about $1.2 billion in student loans; $0.6 billion (technical difficulty) credit card receivables and about $0.1 billion each in auto and CLOs.

(technical difficulty) we invested in $0.4 billion in (technical difficulty) mortgage-backed securities and about $1.0 billion in corporate and municipal bonds.

The aggregate net unrealized after-tax losses in our available for sale and held to maturity portfolios as of June 30, 2010 were $994 million, a $440 (technical difficulty) million dollar or 31 (technical difficulty) improvement from the first quarter of 2010; an improvement of about $3.8 billion or 79% from June 30, 2009; and an improvement of about $5.3 billion or 84% from December 31, 2008.

As of last Friday the net unrealized loss (technical difficulty) $822 million, an improvement of about 17% from June 30, 2010.

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

As of June 30, 2010 our portfolio is 82.3% AAA or AA rated.

The duration of the investment portfolio is about 1.28 years, roughly flat with the first quarter as well as from the second quarter of 2009.

The duration gap of the entire balance sheet as of June 30, 2010 is 0.34 years, up from 0.31 years at March 31, 2010.

The number of downgrades increased from the first quarter, primarily from a continuing trend for downgrades in the US asset-backed securities.

I will now provide some of the assumptions we used in arriving at our 2010 outlook for net interest revenue and net interest margin.

We intend to reinvest about 80% to 85% of the approximately $15 billion in total securities due to mature (technical difficulty) in 2010.

We expect to continue to invest in highly rated agency mortgage-backed securities and highly rated asset-backed securities.

Following the acquisition of Intesa Sanpaolo Securities Services business we adjusted our investment strategy given the uncertainty in Europe.

We decided to leave the acquired customer deposits primarily in the ECB as we continue to monitor market conditions in the euro zone.

Additionally, to protect us against the possibility of sustained lower rates, we adjusted the composition of our US treasury portfolio this quarter increasing our interest rate risk position modestly which was offset by other factors.

As a result of this decision, as well as reflecting the strength of the first half of 2010, we now expect a higher net interest margin including the impact of the Intesa acquisition, but excluding the conduit discount accretion.

(technical difficulty) expect the net interest margin to be between 155 and 165 basis points on average for the year, an increase of 5 basis points from our earlier guidance.

We have seen a steeper yield curve at the short end, which is zero to three months, than we had assumed in our initial outlook.

Also we expect to have a slightly smaller average balance sheet for the year than what we made (technical difficulty) original (technical difficulty).

We now expect earning assets to increase between 2% and 3% from the average in 2009, down from our earlier outlook of a 6% to 8% increase.

We continue to expect the bank (technical difficulty) rate to remain (technical difficulty) 50 basis points for the rest of the year; we continue to expect the ECB to remain at 100 basis points throughout the rest of the year and we continue to expect the Fed to keep the overnight Fed funds rate (technical difficulty) 25 basis points for all of 2010.

(technical difficulty) the S&P 500 to average about (technical difficulty) in 2010, up about 19% from 948, the average in 2009.

Lastly, I'll briefly review our capital ratios.

In the second quarter State Street Corporation's capital ratios remained strong after giving (technical difficulty).

As of June 30, 2010 our Tier 1 leverage (technical difficulty) stood at 7.7%, our Tier 1 capital ratio stood at 15.1%, and our tangible common equity ratio was 6.3% after taking into account the impact of the acquisitions.

So in conclusion, we're pleased with our operating basis results for the second quarter.

While we expect our quarterly results to decline somewhat from the seasonally strong level of the second quarter, we continue to expect our operating basis earning (technical difficulty) for the year to be slightly above the $3.32 level of 2009.

Now I'll turn the call back to Jay to conclude our remarks.

Thanks, Ed.

The results for the second quarter confirm our confidence in our full-year outlook, as well as our expectation that servicing revenues in the second half of the year will be stronger than the first half.

This outlook is based on the contribution of the acquisitions, as well as the expected conversion of client wins from the first half of 2010 that will contribute to service fee revenue as well as several value added services.

As I mentioned, the acquisitions are proceeding in line with expectations.

The performance of Intesa in the second half of the quarter gives us confidence in our outlook for 2010.

The acquisition of Mourant also has given us traction in adding clients to our alternative investment servicing business.

In asset-management State Street Global Advisors continues to position itself to benefit from increased demand from passive strategies and growth in defined contribution plans and ETF investments.

Overall I'm pleased with the performance in the second quarter and encourage that in spite of challenging markets our products and services continue to be in demand across the broad spectrum of institutions we serve.

The growth of our core business and the momentum we have built in the first half of the year reinforce our confidence in achieving operating basis earnings per share slightly above the operating basis level of $3.32 in 2009.

Now Ed and I are happy to take your questions.

(Operator Instructions).

Ken Usdin.

Just a couple of quick ones.

If you normalize out the incentive comp inside the $0.93 number, can you talk to us about what incentive comp would have been and what the EPS number would have been against it and what should we expect for the delta in incentive comp going forward as we kind of think about a normal run rate?

Ken, probably the easiest way to answer that question would be if you look at the second quarter, use $0.06 or $0.07 as a good number for what incentive compensation would have been.

Okay, got it.

So that's what -- so in a normal run rate we would just kind of take that out and then that line item should go back up presuming there are no similar charges in the future quarters?

Assuming performance, correct.

Assuming performance, okay.

And then just -- can you talk us through any update on the legal front related to either the [Calper] suit, whether you've taken any reserves against that, and whether or not you've gotten any incremental inquiries from other states attorneys generals related to the FX issue?

Yes, Ken, there's really no update from prior quarters.

As you know, we've got a dispute which is in litigation with California; there's been no material update since last quarter.

We have received inquiries, as reported previously, from other state attorneys general, but I don't think any additional this quarter.

So really nothing to report and we continue to believe, as we've said all along, that our position is sound and we were acting appropriately and would expect to prevail in the lawsuit.

Okay, got it.

And then, I'm sorry to go back to expenses, and this will be my last one.

Just on -- the other expense control was really good again, as it was in the first quarter of last year.

Ed, can you just give us any thoughts of what a reasonable go-forward run rate is and if there were any items to call out in that other expense line?

Thanks.

Yes, I mean, I called them out in my comments, Ken, where we had a recovery for $11 million associated with Lehman Brothers.

So that's probably a nonrecurring kind of item.

And we had low securities processing costs which has been something that we've been focused on a lot here and we've been pretty successful in that line.

So the result is that we probably had a quarter on that line which is a little bit below what I'd say kind of a run rate is.

I would say just to kind of dimension it a little bit for you -- the first quarter, which was about $245 million this year, is probably slightly above where we'd like to be.

So kind of the run rate is somewhere in between.

Okay, thanks a lot.

Sure.

Howard Chen, Credit Suisse.

Good morning, Jay; good morning, Ed.

Hi, Howard.

On the core servicing fee growth and momentum, Jay, you helped us walk through the momentum and timing of the conversions of the big wins and the deals.

But just could you help us with what you see and anticipate in terms of revenues and earnings as we get the full benefit of Morgan Stanley, state of Ohio, state of New Jersey, and the deals all else being equal in the operating environment?

Yes, I guess, Howard, the best way to -- let me just first give you a little color on what's going on in the marketplace.

I think as investment managers and pension funds are faced with more pressures on their own, we're seeing an uplift in the amount and number of activities that (technical difficulty) sourcing.

I also mentioned -- highlighted a couple of times in my comments that we're seeing in the alternatives world hedged private equity and real estate -- a step up in outsourcing activities in that segment of the market as well.

So we -- if you look at the $1.1 trillion in new commitments this quarter and net out the two acquisitions, I think there's $415 billion or so of new commitments unrelated to acquisitions in the quarter.

I think if you go back two or three quarters, I think in the fourth quarter of last year we started to pick up some momentum that continued through the first and the second quarter.

The tendency of these deals recently is they tend to be bigger, they tend to be as a result a little bit more (technical difficulty) from an implementation standpoint.

The Morgan Stanley commitment took a couple of quarters to get implemented.

So, I think -- hard to dimension specifically, but if you looked at on an ongoing -- there's probably a two or three quarter (technical difficulty) when we talk about $415 billion that hit in the second quarter -- I would guess two-thirds of that gets implemented in the second half of the year and then the first quarter of next year it gets completed.

So a two or three quarter lag is generally probably the best guidance I can give you on that.

Okay, thanks, Jay.

And then just what earnings impact did Mourant and Intesa have on this quarter?

And does everything that happened in Europe, whether it be the currency shift or just micro-conditions, change your view at all about the accretion targets?

Yes, it was a pretty modest effect, Howard, given when we closed the (technical difficulty) which was Intesa in the middle of May, so we only had six weeks of Intesa.

So, I'd say around $0.01 or so.

Our thinking in terms of the full year is still modest accretion.

I think on the last call I quantified that as around $0.05.

I'd say we're still in that range I'd say.

Our thinking relatively to Europe was to be cautious which is why we left the Intesa deposit principally at the ECB.

But that's not something that we've decided to do (technical difficulty) for the full year.

So, we'll evaluate it as the year unfolds and we still expect the two acquisitions to be in the range of $0.05 accretion for the year.

Great, thanks.

And then the final one for me.

At the analyst day your view on reg reform was that it was fairly de minimis, impacted others more just to paraphrase.

I guess we're still waiting on final rules, but just any evolved or latest thinking on broader reg reform?

Broader than the recent bill that is being -- is working its way to the White House?

Maybe just the recent bill (inaudible) .

Yes, the recent bill.

As I said in my comments, we don't think it was really intended at the trust (technical difficulty) banks.

Having said that, it is a big bill with a lot of moving parts.

We were pretty active in making sure that around the edges there wasn't anything that had an unintended consequence for any of the (technical difficulty) activities that we conduct.

So we've gone through a good part of the (technical difficulty) as you know (technical difficulty) to move into the (technical difficulty) phase.

(technical difficulty)

One moment, please.

Mike Mayo, CLSA.

Hi, it's Mike Mayo at CLSA.

Can you hear me?

We can hear you, Mike.

Okay, there was a little disruption there for a second.

I was trying to get a handle of your core growth in securities servicing.

So 9% linked-quarter growth is 36% annualized.

I don't think you would want us to annualize that.

So can you give us a little bit more color, what would the revenue growth be if you had not had the acquisitions this quarter?

Do have that number?

Well, the Intesa for the quarter was around $30 million on the servicing fee line.

I'm sorry, was that $30 million?

3-0, yes.

Okay.

Okay.

Mourant was about $20 million.

So backing out (technical difficulty) from the growth, this is -- do you have the (technical difficulty) for the quarter, Mike?

Just first quarter to second quarter, I was just --.

First quarter to second quarter.

(Operator Instructions)

So is that about 3% or 4% quarter, Ed?

So annualized, you are still low double digits?

Yes, yes.

Okay.

And who are you winning the business from?

I ask this question all the time.

Because Bank of New York is winning, JPMorgan is winning, Northern trust is winning.

So showing double-digit core growth in securities servicing is good, but others are doing it too.

So what present of your wins are from the other, say, top five players versus the rest?

A couple comments, Mike.

You know, I would say that a good deal of the wins, and you almost have to look at it by segment if you are looking at the alternatives as a segment or if you look at the middle office as a segment.

The wins are coming from in-house installations.

So I think part of the answer is it represents an expansion of the market, so it's not coming from traditional competitors.

And the alternative segment is driving a good deal of our growth, that's a factor.

And some of the large outsourcing (technical difficulty) where middle office is a factor, that's also a factor.

So, I'd say some of the answer is (technical difficulty) the pie is expanding.

And another part of the answer I think is that -- I think that the disproportionate share of new mandates is going to the bigger players.

You look at some of the boutique providers in different aspects of the investor servicing world, I think there's greater comfort in the bigger, larger scale players that have a global footprint.

I think when you put those things together it could explain part of why the growth is occurring on multiple fronts.

We do believe, having said that, that we're getting more than our share.

If you look at the middle office, which a lot of these big deals, Morgan Stanley being one I would just highlight -- back at the investor day I highlighted some industry data which had us in excess of 50% market share in the middle office.

Also by far the leading provider in alternatives.

So I think head to head we feel good about our performance.

But I'd also make the point that the pie is expanding.

All right, and last follow-up.

Pricing, I asked this at your investor day and I got the sense that you might not increase prices on the core business as much as maybe try to get some secondary services, maybe more trading or FX securities lending.

What's the current state of trying to improve pricing or get more kind of bang for your buck when it comes to securities servicing?

Mike, that's still a pretty good read.

I think that -- I think it's difficult to get (technical difficulty) expansion and fee-based revenue.

But it's easier to find ways where we can expand the relationship to the benefit of the customer and to the benefit of the economics of the relationship.

I would also say that it's specific to customers and that if we have a pricing arrangement that is somewhat dependent (technical difficulty) like securities lending and a customer (technical difficulty) securities lending, we have a (technical difficulty) economics.

All right, thank you.

You're welcome.

Brian Foran, Goldman Sachs.

Thanks.

I guess when we try to think about a normalized sec lending revenue run rate, how should we think about the cost of a shorter duration sec lending book?

Certainly the 17 basis points sounds lower risk, but how much does that cost you on the revenue -- 17 days weighted average maturity I should say -- but how much does that cost you on a revenue perspective?

I think the bigger, Brian (technical difficulty) Fed funds LIBOR rate (technical difficulty) a couple (technical difficulty) quarter was (technical difficulty) 30 now.

So the duration which came in a little bit is (technical difficulty) greater factor (technical difficulty) the Fed funds to three month (technical difficulty) duration.

Okay, thanks.

Gerard Cassidy, RBC Capital Markets.

Thank you, good morning.

Regarding the -- making the sec lending assets whole with the contribution that you made in the quarter, and I think you said you're going to let down the gates in mid-August or customers could take their money out.

What do you expect in terms of the customer reaction and do you expect a flood of customers to come to get their money?

Yes, the -- let me give you a little color on that, Gerard.

The announcement we made two weeks ago really was -- had two dimensions to it.

One was for SSgA where we sponsor funds and we have a lending option.

In that case we infuse cash into the funds to get them to $1 NAV as of the second quarter.

As of mid-August we will let the gates down and therefore people have (technical difficulty) to move out of (technical difficulty) lending (technical difficulty) want to.

We expect that some number of customers will move into non-lending funds within SSgA.

So we (technical difficulty) out of that (technical difficulty) other thing that was (technical difficulty) obvious (technical difficulty).

So my prediction is that in the short term we'll see some movement (technical difficulty) funds, but over time I think it will be a positive (technical difficulty) in that they'll now be able to sell (technical difficulty) lending.

The other dimension to that announcement was really on the direct lending program where we're going to create the two pools, that will occur at the end of the year where people have complete liquidity in one pool and the other pool with longer dated (technical difficulty) we'll have less liquidity.

Does that help, Gerard?

Yes.

And how big are the two pools -- do you expect those two pools to be at the end of the year, about?

I don't think we've given (technical difficulty) it's not two pools, it's (technical difficulty).

Hello?

You're breaking up.

Ladies and gentlemen, please hold.

Ladies and gentlemen, I do apologize.

The conference will resume momentarily.

Cassandra, are we live with you now?

Okay, all right.

Mr.

Cassidy, you may resume.

Oh, thank you.

One final question, Jay.

In terms of when the redemptions come in in August assuming you get some customers that redeem.

Is there -- what kind of impact to revenues or earnings could we see from that, or will there not really be any impact?

You know what, I don't envision that there will be any material impact.

I think you'll have some customers move to non-lending funds.

On the other hand, it's hard to predict how much new flows we'll have.

So we're not predicting any material change as a result of that.

Thank you.

You're welcome.

Brian Bedell, ISI Group.

Can you hear me?

Yes we can, Brian.

Okay, great.

Just to zero in on the servicing fee line again and the conversion pipeline.

So, I guess a couple of questions around that.

First of all, I guess what incremental revenue impact should we see in the third quarter from the Morgan Stanley conversion, understanding that that was converted during the second quarter?

I guess what I'm getting at there was the timing of when that was sort of completed.

And then for the New Jersey, Ohio state -- I thought Pine Bridge was being converted in the second half as well.

If you can talk to just conversion aspect of the --.

Yes, probably they're all specific.

Let me just -- the one I can probably hit specifically would be Morgan Stanley which was probably half installed in the second quarter.

So, you can project that forward into a full-year run rate, Q3 and Q4 and beyond.

Beyond that I think you probably should be guided by the aggregate AUC sales in the third quarter, fourth quarter, first and second quarter to get some sense of the momentum or what we're likely to see in the fee revenue line.

Right, right, okay, okay.

And you're getting a higher realization or fee rate on Morgan Stanley and the other mid-office stuff then, than clearly the state of New Jersey and Ohio I would assume, right?

That's part correct, in aggregate it would have higher revenues than the pension business.

Right, right.

And was there any unusual impact in the second quarter from the -- just the way the markets moved during the quarter?

I know there's -- I'm sure there was a currency impact.

Maybe if you could state that as well.

But outside of that as a model going forward should we just look at your normal relationship of 10% market move equates to a 2% revenue move?

Or was there something else different in the second quarter in that?

Yes, Brian.

The 10%, 2% still holds.

And in the quarter the servicing fee line was depressed by $12 million because of the stronger dollar.

Okay, okay, great.

And then on the brokerage fee line, that was a little bit higher than I was expecting.

Can you just talk about what's driving that?

Is that all current X or were there other trading (inaudible)?

And I guess what's your outlook for that going forward?

This is not -- the brokerage line, not FX.

Yes, I mean we had a strong quarter relative to both current X and electronic trading broadly as well as transition management.

And transition management, okay.

So that was transition was elevated in this second versus the first?

Yes.

Yes, okay.

And continue to expect that to be lumpy, I assume?

Yes, it's historically been lumpy, so there's no reason to think otherwise.

Right, right, okay.

And then on the operating processing area that looked like it was -- like you said, it was low.

The range you were talking about, was that the range -- between $186 million and $245 million is an approximate range we should expect going forward?

Yes, I was trying to narrow it down a little bit with the first quarter being a little high and the second quarter being a little bit below trend and giving you a sense of where you should be thinking about it going forward.

Right.

So if you're successful in your strategy in reducing operating errors going forward should we think of that range being closer to the lower end of that range?

Or are there other investment projects that are ongoing that might put you back in the (multiple speakers)?

Yes, there are other things that go into that line besides the securities processing cost.

So, and there is some variability around those numbers, we also have some control over some of those numbers, like professional services and things like that, as we've talked about.

So I wouldn't want to pin it down to a point estimate, Brian.

But I think, if you think about it around the midpoint of the two quarters of this year, it's probably not too far from where we expect it to be.

Okay, great.

And then just lastly, the tax rate outlook for the third quarter?

Yes, we expect full year to be between 28% and 29% on an operating basis.

That view hasn't changed.

Okay, great.

Thank you so much.

Sure.

Tom McCrohan, Janney.

(technical difficulty) taking the call, the question.

This morning your competitor talked about increased compensations about some type of creative partnerships with some of their clients.

They really weren't very specific on what that entailed.

But are you also talking about partnerships with certain asset managers or other financial institutions right now?

And if so can you kind of elaborate on that?

Around partnerships, no, I'm hard pressed to understand what they were talking about.

We consider all of our relationships partnerships and we're continuing to look for ways to expand our share of wallet, which we've had some good success in.

Okay and then, Jay, maybe just more specific, on the outsourcing side it sounds like there's increased interest in that kind of offering.

Could you drill down a little bit on what -- where that demand is coming from specifically, what type of asset managers or financial institutions have an interest in that right now?

Sure, Tom.

Almost by definition the investment manager outsourcing is a product not for the pension world, but rather for the investment management world.

And we've seen a pretty broad take up across traditional asset managers as well as alternative hedge and private equity.

I'd also say that demand is almost across the board from a geographic standpoint.

So, what we've tried to do with that is to position it against the largest and more sophisticated because we have a product that we think is oriented best in that space.

And as a result of that we've enjoyed the market share that I referenced earlier.

I would say as a general comment the demand is quite strong and I would expect, and you would know this yourself.

If you look at the pressures investment managers are under not just to contain costs but to develop new compliance capabilities, new risk reporting to accommodate new asset types at the same time accommodating new regulation, the last thing in the world that they generally want to invest in is the infrastructure of their middle office.

So, I suspect that demand, and we've thought this for a long time, will be out there for quite some time.

That's great.

And can I ask one last question on the brokerage side?

Trading volumes are down kind of in the industry; across the board.

You're seeing that at some of the broker-dealers, but you guys had a pretty strong quarter on the trading side.

So what specifically is driving that strength in light of lower trading volumes across the industry?

I would say two things.

One is in the pure trading space we've seen for many -- for several quarters now steady growth in our electronic trading.

So, between current X and FX Connect, the electronic element of trading has I think across the industry continued to take share.

We're participating in that.

The other thing I would highlight is the point Ed made earlier which is transition -- transition management, which is a brokerage activity that is a byproduct of an institution that changes their asset allocation as they change asset allocation a transition manager is often invoked to help transition the portfolio from say a fixed income to equity or within the equity asset classes.

In 2009 I would say the movement of assets based on new allocation strategies was constrained.

And we've seen in the past several quarters that seems to be loosening up.

So transition management begets brokerage and, given our positioning with the institutional world, I think we're pretty well positioned to continue to see transition management growth.

Okay, thank you.

You're welcome.

John Stilmar, SunTrust.

Good morning, gentlemen.

Thank you for allowing me to ask my question.

Good morning, John.

Good morning.

The first question has to do with a little bit more detail with regards to the middle office and outsourcing function.

And the sort of very simple way we've -- or I've traditionally thought about the servicing business is that servicing assets have grown relatively in line with services revenues.

This quarter obviously challenges that view and congratulations on hitting your guidance.

But I guess as we look forward and that middle office functionality seems to be far more profitable and that historical relationship of assets not necessarily growing the same amount of servicing revenues.

How would you think that historical relationship over the coming quarters and years would progress given the mix of business maybe towards more service oriented, outsourcing function that may provide a revenue growth outside just traditional asset growth.

I was wondering if you could kind of at least frame that theme for me.

Well, I'll take a shot at it, John, the -- and I'll run it beyond middle office.

Our preposition, our thesis with our customers is that we began doing business, we begin doing business generally with a custody and accounting relationship and are continuing to look to expand that into the trading space, into middle office into compliance, more recently collateral management has been a big theme, derivatives processing.

So, as you know from the past, most years 70% of our incremental revenue comes from our existing customers; oftentimes there's an anchor relationship around custody, but a lot of the servicing fee revenue emanates from those cross sell products that can be middle office or other reporting or trading activity.

So, I don't think anything has changed.

We continue to pursue custody based books of business, but we're also generating pretty good growth by cross-selling the -- not only the products we have, but continuing to develop a new series of products to meet today's needs.

Likely what is the percentage of revenues in the servicing sector that are tied to assets versus tied to services?

I think they're all generally tied to assets and that we have -- you can count them on one hand -- relationships where we're not doing the underlying custody.

And that segment would be largely the prime brokerage aspect of alternatives.

But everything else is really tied to that custody relationship, accounting, compliance, transfer agent, it's all founded on the custody relationship.

Okay, thank you.

And then one of the themes that you brought out pretty evidently in your analyst date was long-term growth towards Europe and potentially -- and even potentially acquisitions coming from some of the challenges that you saw over there.

One, can you update us on our thoughts about that?

And then does that theme still hold true?

And then a final update on your thoughts on M&A, has anything changed since the analyst day?

I think probably nothing has changed since the analyst day.

The thesis was that if you look at the trust and custody space and you look at the European markets there are still quite a few, I think we said eight to 10 or 12 custodians, are your subscale custodians in Europe tied to bigger banks.

The thesis was that as banks look to potentially raise capital or potentially look to shed non-core businesses that we would have an opportunity to take advantage of that.

The Intesa acquisition, which we closed in the second quarter, is symptomatic of what you might see, which is a large bank that has a small footprint in the custody space might look to exit that.

In the case of Intesa we were fortunate enough to buy it.

So, I think that our view back in May still stands and in fact it's probably an even stronger view when you consider what the European banks are going through, the stress test and the like and the greater likelihood that they would conclude that the subscale custody business isn't a long-term business for them.

Perfect.

Thank you guys so much.

You're welcome.

James Mitchell, Buckingham Research.

Good morning.

Just a couple of quick follow-ups, maybe speaking to the sec lending business, we've seen Fed funds, LIBOR spreads widen pretty meaningfully throughout the quarter.

I think in April we were around 10 basis points and we're now at 30.

How much do you think that was reflected in 2Q securities lending spreads and revenues versus how much if that were to stay at 30 through the third quarter?

Is it half in 2Q, a quarter, three-quarters, how should we think about that?

I think about it in terms of it being half or so in Q2, about half the quarter, let's say.

Okay, that's helpful.

And then on -- just skipping around on the expense side, your guidance in between first quarter and this quarter, does that include the impact of Intesa which was only in six weeks?

Yes.

Okay.

But we should also see an uptick in the revenue side because you only had six weeks from Intesa, you said about $30 million in the quarter?

Yes.

Okay.

I think -- oh, and lastly.

Did you disclose -- I didn't hear -- net inflows in asset management or outflows?

No, we did not, James.

I can get back to you with that, James.

I have it, but it's not right at my fingertips.

Okay.

That's all I've got, thanks.

You're welcome.

Vivek Juneja, JPMorgan.

(technical difficulty) full of questions.

Agency MBS, can you talk a little bit about why they're up 30% this quarter, up very strongly given that you've said you've been wanting to reduce risk in the portfolio?

Well, what we said was that we wanted to continue on course with our reinvestment strategy.

And we think that the agency MBS asset class is an attractive one.

We don't necessarily want to be on the sidelines and not be investing through cycles.

We've said we want to invest consistently in terms of monetizing the liabilities that we have on the balance sheet.

And agency MBS, we thought, was a good category this quarter to invest in.

Even though you do run duration risk eventually when rates go up and prepayment speeds slow down?

Right, right, we're unaware of that.

But again, given our desire to not be on the sideline and be short and be let's say all in floaters until rates go up, we thought that that was a good trade for us and consistent with our strategy.

It's all AAA.

Okay.

Second question, other expenses, the last couple of years they've tended to jump pretty sharply in the fourth quarter, granted a little bit of non-recurring, but even ex that big jumps in the fourth quarter.

So it tends -- is there any reason to expect that that won't be the case this year?

Well, there are reasons why, I'm sure I don't have them at my fingertips, as to why expenses -- other expenses may have spiked in the fourth quarter and prior years.

But my comments earlier, which is to think about the other expense line for the rest of the year between the first-quarter and the second-quarter numbers I think still holds.

So based on that I'd say the answer to your question is no.

What is it about the securities processing line that causes such variability quarter to quarter, particularly given that you're getting so much new business, new client flows and you're certainly not seeing that in the transaction processing line?

Could you walk us through that?

Yes, well the securities processing costs that we refer to are varied and they can move around, it depends on what the actual activity levels are in the specific things that we have to face.

We've had a very significant effort through time to focus on that line and frankly have been successful.

But the line includes various clearance-related costs, pricing discrepancies, if there's an execution error or a data entry error, something like that, as well as related interest or foreign exchange effects of any of those items.

So it's pretty varied, comprised of a lot of elements and can in fact move around.

But we think we've -- I've said had a pretty good handle on it and have made significant improvements there that we think are in fact fairly sustainable through time.

Okay, great, thanks.

Sure.

Jeff Hopson, Stifel Nicolaus.

Okay, thanks a lot.

Shifting over to asset management real quick, you've got pretty good momentum there.

And obviously passive has been more in vogue I guess from secular and cyclical standpoint.

Also wondering if of the Barclays, BlackRock combination -- if you've seen any fall out from there or would you say it's primarily from more of a secular passive trend?

Yes, Jeff, I would say it's more the latter, which is we've seen and continue to see some move to passive.

We also in the quarter saw some nice growth in fixed income, active fixed income.

And we also continue to see steady growth in the ETF product line both -- most prominently in the gold ETF which had good growth, but also the fixed income ETF's which are on a small base but continue to show good growth.

So, more to secular trends.

Okay.

And in terms of competition on the passive side, it seems like I guess there are fewer big players there.

Would you say that's true on a global basis?

And then any particular new fee -- I guess competitive pressure on the fee side there?

No, I think the passive space is and has been domestically and globally fairly concentrated to a small handful of players for some time.

You could even extend that to the ETF marketplace which has a passive orientation to it.

So I don't think we've seen for some time any meaningful change in the competitive landscape from the standpoint of the passive industry.

Okay, great.

Thank you.

You're welcome.

Cassandra, I think we have time for one more call -- one more question.

At this time there are no further questions.

Do you have any closing remarks Mr.

Hooley?

No, just looking forward to speaking to you next quarter.

This concludes today's conference call.

You may now disconnect.