道富銀行 (STT) 2012 Q2 法說會逐字稿

Good morning and welcome to State Street Corporation's second-quarter 2012 conference 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 express written authorization from State Street, and the only authorized broadcast of this call is housed on State Street's website.

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

(Operator Instructions).

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

Please go ahead.

Before Jay Hooley, our Chairman, President, and Chief Executive Officer; and Ed Resch, our Chief Financial Officer, 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 2011 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 statement speaks only as of Tuesday, July 17, 2012, 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 presentation regarding the Corporation's investment portfolio, as well as our second-quarter 2012 earnings news release, which includes reconciliations of non-GAAP measures referred to on this webcast, in the Investor Relations portion of our website.

Also, in the addendum to the news release on the last page, you'll find some specific estimates of our Basel III ratios, giving effect to the notices of proposed rulemaking issued in June 2012.

Now I'll turn the call over to Jay.

Thanks, Kelley, and good morning, and thanks to all of you for joining us on the call this morning.

Overall, our financial results improved in our second quarter from our first quarter of 2012, with a 20% increase in operating basis earnings per share, but were affected by increasing weakness in international markets, reflecting global concern about the stability of the Eurozone.

We remain cautious in our outlook for the second half of the year, and very focused on delivering value-added solutions to our clients and controlling expenses.

Our business operations and information technology transformation program has contributed to our results in a difficult market environment while positioning us favorably when the economic outlook improves, and has also enabled us to accelerate new product development for our clients.

In addition, the reduction in compensation expenses and strong expense control, coupled with business momentum, enabled us to achieve positive operating leverage in the second quarter compared to the first quarter of 2012 on an operating basis.

The ratio of compensation expenses to total operating basis revenue improved to 38.8% in the second quarter as a result of the absence of the seasonal accounting effects related to retirement-eligible employees recorded in the first quarter, and the continuing success of the business operations and information technology transformation program.

Our capital position remained very strong and allowed us to repurchase $480 million of our common stock in the second quarter of 2012 and to increase our quarterly common stock dividend in 2012 to $0.24 per share.

In addition to remarks about our second-quarter results, this morning I'll address our continuing success in generating new business in our core asset servicing and asset management business; our economic outlook; the ongoing progress of our business operations and information technology transformation program; as well as our strong capital position.

The growth of both our fee-based businesses and our total revenue in the second quarter compared to the first quarter was affected by the de-risking activity of our clients in the second half of the second quarter.

Our results reflect stronger US equity evaluations early in the quarter as well as the seasonal strength in securities finance, but equity markets became more volatile later in the quarter and remain so today.

Capital markets affecting foreign exchange and trading were weak throughout the quarter.

Compared to the first quarter, the impact of the new business we won and installed plus the business we won in past quarters provided some strength in our core business revenue in the second quarter.

We continue to add new servicing business to the core franchise.

Of the $133 billion in assets we won in the second quarter, about 48% were from the US and 52% from international markets.

The Board of Trustees of the $36 billion Maryland state retirement and pension system renewed its global custody contract.

We won a significant mandate for servicing collective funds from a Middle Eastern client to service their conventional and Sharia-compliant fund umbrellas.

Mitsui Fudosan, a Japanese real estate firm, has extended its relationship with State Street to include administration, registrar, and trustee services for two additional New Jersey property unit trusts.

The endowment fund at Emory University has expanded its custody and accounting services, now including risk analytics services for its $5 billion endowment.

The integration of the acquired Intesa security services business has met our stated targets, and our presence in Italy continues to attract new business.

Just recently SSgA was appointed as investment manager for EUR110 million in assets for the Italian pension fund of employees of RAI, the Italian public television network.

SSgA has also been selected by family investments to manage a combination of passive equity and fixed-income strategies for GBP1.5 billion in assets, as well as a tactical asset allocation overlay for the majority of these assets.

Regarding the timing of asset-servicing installations, during the second quarter we installed $130 billion, $79 billion of which was awarded in the second quarter and $51 billion was awarded previously.

Of the total business awarded in the second quarter, about $55 billion remains to be installed.

In the alternative asset servicing area, demand remained strong.

In the second quarter we added 32 new mandates in our alternative investment servicing business, and our assets under administration were $877 billion as of June 30, 2012.

We announced the proposed acquisition of Goldman Sachs hedge fund administration business earlier today.

This business had a total of $200.6 billion in assets under administration as of March 31, 2012.

This acquisition would increase our alternative assets under administration to a level which solidifies our lead in servicing this fast-growing asset category.

We expect this acquisition to be accretive in earnings in the first year of operation on a cash basis, excluding one-time costs.

Let me now share our outlook for the global economy.

The lack of stability in Europe seems to be dominating every macroeconomic headline for the past two months.

The election in Greece was positive, but the outcome has not been persuasive enough to alleviate concerns that Greece may exit the euro.

Questions were also raised in the market about the stability of Italy and Spain.

The decision by European leaders in late June to create a single supervisory body to oversee the recapitalization of Euro-area banks alleviated some of the concern, but until the European stability mechanism is in place and functioning, the uncertainty in Europe will overhang the economy.

Looking forward, we expect global GDP to rise a somewhat anemic 3.2% in 2012, reflecting slow growth in the advanced economies and more marked slowing in the developed ones.

We expect the US recovery to remain lackluster, with 2012 GDP growing slightly above 2%, up from 1.7% in 2011, but slow by historic standards.

While we currently believe that the GDP may increase in 2013, our view of 2013 is dependent on the likelihood of legislation to extend the Bush tax cuts and reductions in the federal budget.

Although consumer confidence in the US has improved slightly, and there are signs that housing prices are stabilizing, unemployment continues to be a problem, with a worsening in the expected rate of unemployment for 2012.

In the UK the GDP declined in the first two quarters of 2012.

The number of unemployed increased, and so technically, the country has slipped back into recession.

The Eurozone economy rebounded in the first quarter, but then stagnated in the second.

Based on our current outlook, we expect the GDP in the Eurozone to contract about 0.5% in 2012, followed by a slight improvement in 2013.

On balance, our outlook is cautious, primarily due to European uncertainty and the effects that it may have on the US economy.

The performance of our business operations and information technology transformation program continues to meet our expectations.

In 2012 we expect that we'll achieve approximately $94 million in annual pretax run rate operating basis expense savings, resulting in a total of $180 million of pretax run rate operating basis expense savings since the beginning of the program.

In 2012 we expect the greatest benefit to come from the business operations transformation as we deploy automation and reconfigure our operations to more efficiently meet the needs of our global client base.

We are also focusing on transferring certain aspects of our IT management to our service providers as we prepare for the migration of many of our existing and new applications to the cloud environment in 2013 and 2014.

We are training our IT developers on cloud technology and are currently running applications using this technology in our production environment.

Our capital ratios remain strong after paying a $0.24 per common share quarterly dividend and purchasing $480 million of our common stock in the second quarter.

In addition, we announced the proposed acquisition of Goldman Sachs hedge fund administration business at a purchase price of $550 million, which we expect to close in the fourth quarter, subject to regulatory approval.

I'll now turn the call over to Ed.

Then I'll provide some final remarks before we open the call to your questions.

Ed?

Thank you, Jay, and good morning, everyone.

This morning I'll review three areas.

First, the results for the second quarter; second, I'll summarize the performance of an outlook for the investment portfolio, as well as worldwide interest rates and the impact of our non-interest margin; and finally, I'll review our strong capital ratios.

I'll present some of the more significant results comparing the second quarter of 2012 to the second quarter of 2011, as well as to the first quarter of 2012.

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

Our total revenue was down 2% compared to the second quarter of 2011 and increased 1% compared to the first quarter of 2012.

The year-over-year decline was primarily due to the effects of weaker international markets.

The quarter-over-quarter increase was due to seasonality in securities finance and strength in net interest revenue, offset partially by weakness in international markets.

Fee-based revenue in the second quarter was down 6% compared to the second quarter of 2011 and was approximately flat with the first quarter.

Compared to the second quarter of 2011, servicing fee revenue declined 3%, primarily due to the impact of weakness in international markets and the effect of the weaker euro, offset partially by net new business and a 2% increase in the daily average of the S&P 500.

Compared to the first quarter of 2012, servicing fees increased 1% due to net new business, offset partially by weaker international daily equity valuations.

In our servicing business, clients derisked their investment preferences later in the second quarter, primarily moving from US domestic and emerging market equity funds to fixed income and government funds.

Management fees were down 2% from the second quarter of 2011, primarily due to weakness in month-end international equity valuations, offset partially by new business; and increased 4% from the first quarter due to new business, offset partially by weaker international month-end equity valuations.

Given the continued weakness in international markets, we are adjusting our assumption for the 2012 EAFE average to decline to about 1400 for the full year, down 12% from 1590 in 2011 and revised from our assumption of 1490 earlier this year.

At SSgA net new business was a negative $6 billion.

This was composed of inflows into ETFs, adding about $7 billion in net inflows, with about $1 billion net into institutional and fixed-income funds, which were primarily passive, offset partially by $12 billion in cash outflows, primarily due to the reduced positions in securities lending collateral as the seasonal impact of the dividend season in Europe dissipated, and $2 billion have of outflows from active and enhanced equity funds as clients derisked.

Our money market fee waivers were $7 million, a decline from $9 million in the first quarter of 2012.

Regarding trading services and securities finance, trading services in the second quarter of 2012 declined 18% compared to the second quarter of 2011 and declined 9% compared to the first quarter of 2012.

Compared to the year-ago quarter and the first quarter of 2012, second-quarter foreign exchange revenue decreased 24% and 13%, respectively, with both declines due primarily to lower volatility, reflecting weak capital markets, offset partially by slightly higher volumes.

Compared to the second quarter of 2011 and the first quarter of 2012, brokerage and other fee revenue declined to 11% and 4%, respectively, due primarily to weaker revenue from sales and trading.

In foreign exchange, the second quarter of 2012 the percentage of total foreign exchange revenue generated by our indirect offering decreased about 12% from the first quarter compared to a 15% decline in revenue from the direct foreign exchange services, both of which reflected overall weakness in the capital markets.

Compared to the second quarter of 2011, securities finance revenue increased 4% in the second quarter of 2012 due to higher spreads, offset partially by lower volumes, and increased 47% compared to the first quarter of 2012, due primarily to the normal second-quarter seasonal increase.

In the second quarter of 2012 the average three-month LIBOR to Fed funds effective rate was 30.2 basis points compared to 16.1 basis points in the second quarter of 2011 and to 39.9 basis points in the first quarter of 2012.

Securities on loan averaged $337 billion for the second quarter of 2012, down from $379 billion for the second quarter of 2011 due to lower demand, and up from $331 billion for the first quarter of 2012, due principally to seasonality.

Average lendable assets for the second quarter of 2012 were about $2.36 trillion, down 0.5% from $2.37 trillion in the second quarter of 2011, and flat with the first quarter of 2012.

As of June 30, 2012, the duration of the securities finance book was approximately 18 days, flat with the second quarter of 2011 and up slightly from 16 days in the first quarter of 2012.

Processing fees and other revenue was $48 million, down 31% from $70 million in the second quarter 2011, due primarily to a gain on an early termination of a lease in the second quarter of 2011, and additional amortization expense in the second quarter of 2012 related to our tax-advantaged investments.

Compared to the first quarter of 2012, processing fees and other revenue decreased 49% from $94 million, due primarily to the positive first quarter 2012 impact of fair value adjustments related to positions in the fixed-income trading initiative and second-quarter 2012 amortization expense related to our tax-advantaged investments.

Operating basis net interest revenue of $629 million in the second quarter of 2012 increased about 14% compared to the second quarter of 2011, primarily due to a higher level of earning investments, including a larger investment portfolio as well as lower funding costs, partially offset by lower yields on our earning assets.

Compared to the first quarter of 2012, operating basis net interest revenue increased 4%, primarily due to lower funding costs and a larger investment portfolio, partially offset by lower yields on assets generally.

In the second quarter, access client deposits averaged about $15 billion compared to $18 billion in the first quarter.

Our operating basis net interest margin was 154 basis points in the second quarter of 2012, up slightly from 152 basis points in the first quarter of 2012.

Now turning to expenses, compensation and benefit expenses decreased 7% or $67 million to $942 million from the second quarter of 2011, primarily due to the impact of cost savings resulting from lower incentive compensation, and 11%, or $122 million from the first quarter 2012, primarily due to the impact of the seasonal accounting affects of approximately $105 million of equity compensation for retirement-eligible employees and payroll taxes in the first quarter.

Additionally, both periods benefited from the business operations and information technology transformation program savings, which were offset partially by the effect of merit increases effective April 1, 2012.

In the second quarter of 2012 compensation and benefits expenses were approximately 38.8% of total operating basis revenue, down from 44.3% in the first quarter.

For the full year we continue to target a reduction of the ratio of compensation and benefits expenses to total operating basis revenue by about 100 basis points compared to 40.2% in 2011, assuming a modest increase in total operating basis revenue, an outlook which appears less certain now than in the first quarter.

The increases of 5% and 9% in information systems and communication expenses compared to the second quarter of 2011 and the first quarter 2012, respectively, were due primarily to the transfer of certain IT functions to our service providers as part of the business operations and information technology transformation program.

Operating basis other expenses were $291 million, up 20% compared to the second quarter of 2011 and up 19% compared to the first quarter of 2012.

Both increases were due to higher securities processing costs and increased professional fees, driven by regulatory initiatives.

Our business operations and information technology transformation program is on track.

You can particularly see the progress we are making in the reductions in compensation and benefits expenses.

In our operating basis expenses we incurred $25 million of nonrecurring costs related to the program, consisting of $20 million in compensation and benefits expenses and $5 million in several other expense lines in the income statement.

As you may recall, we had previously indicated that we expect our nonrecurring costs to peak in 2012 at average of about $25 million per quarter.

Now let me turn to the investment portfolio.

Our investment portfolio as of June 30, 2012, of $114.4 billion increased about $8 billion compared to June 30, 2011.

During the second quarter we invested about $7.9 billion in highly-rated securities at average price of [$102.5], and with an average yield of 1.95%, and a duration of approximately 2.54 years.

During the quarter we invested about $3.3 billion in agency mortgage-backed securities and $2.7 billion in asset-backed securities.

The remainder was primarily invested in small denominations of commercial mortgage-backed securities and in corporate and municipal bonds.

The aggregate net unrealized after-tax loss in our available-for-sale and held-to-maturity portfolios as of June 30, 2012, was $54 million compared to a net unrealized after-tax loss of $81 million as of March 31, 2012.

The improvement in the net unrealized after-tax position compared to March 31, 2012, was due primarily to the benefit of lower rates, offset partially by the impact of wider spreads.

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

As of June 30, 2012, our portfolio was 89% AAA or AA rated.

The duration of the investment portfolio was 1.59 years at June 30, 2012, up slightly from 1.57 years at March 31, 2012.

The duration gap of the entire balance sheet was 0.41 years, down from 0.49 years at March 31, 2012, and this duration gap is in line with our guidelines.

As of June 30, 2012, 57% of our investment portfolio was invested in floating-rate securities and 43% in fixed-rate securities.

Regarding the European assets, we have no direct sovereign debt exposure to the peripheral countries of Greece, Spain, Portugal, Italy, or Ireland in our investment portfolio.

Of our non-US assets, we hold about $900 million in securities from 4 of those peripheral countries, primarily RMBS and all floating-rate securities.

These entail $400 million of securities from Italy; $300 million from Spain; and about $100 million each from Ireland and Portugal.

All of these securities are performing well, except for a few bonds.

We sold all of our Greek securities during the second quarter, about $91 million worth, and recorded a non-operating pretax loss of about $46 million.

On page 7 of the investment portfolio presentation we list all of our non-US investments and show the average rating as well as the types of assets we hold.

Our primary non-US holdings are British, Australian, German, Canadian, and Netherlands securities, totaling 91% of the non-US investment portfolio.

At SSgA, our Eurozone exposure in the investment funds is consistent with client mandates.

We hold the non-US fixed-income portfolios in line with our benchmark weightings, and our actively-managed cash portfolios have no direct exposure to the peripheral countries.

Regarding pretax conduit-related accretion, we recorded $123 million in the first half of 2012, and looking forward, we expect to record a total of about $900 million in interest revenue from July 1, 2012, through the remaining terms of the former conduit securities.

These expectations are based on numerous assumptions, including holding the securities to maturity, anticipated prepayment speeds, credit quality, and sales.

Now for our outlook for net interest margin.

First of all, let me emphasize that we continue to believe that we should invest through the cycle.

We also intend to invest almost exclusively in highly-rated AAA or AA agency mortgage-backed and asset-backed securities.

I'll now review some of the assumptions we use in determining our 2012 outlook for net interest revenue and net interest margin.

We believe that the Federal Reserve will leave interest rates on hold through the end of 2014.

The ECB has recently cut rates to 75 basis points and adjusted its deposit facility rate to 0%.

We expect these two actions to reduce our net interest revenue in the second half of 2012 by about $20 million.

We expect the ECB to hold these rates through the end of 2012.

We believe the Bank of England will hold its base rate at 50 basis points through 2012.

If the Bank of England were to lower its base rate by 25 basis points, it would lower our net interest revenue by about $5 million annually, assuming market rates fall in relation to administered rates.

Based on these rate assumptions and our second quarter results, if our excess deposits remain at the current level, our net interest margin for the full year 2012 will likely be in the middle of our 145 to 155 basis point range.

Finally, I'll briefly review our capital ratios.

In the second quarter, State Street Corporation's capital ratios under Basel I remained very strong.

As of June 30, 2012, they were -- our Tier 1 risk-based capital ratio stood at 19.9%; our total capital ratio stood at 21.5%; and our Tier 1 common ratio was 17.9%.

Our Tier 1 leverage ratio stood at 7.7%, and our tangible common equity ratio was 7.2%.

The impact under Basel I and of the acquisition of Goldman Sachs's hedge fund administration business is expected to reduce our June 30, 2012, Tier 1 risk-based capital ratio by 75 to 80 basis points.

I'll now direct your attention to the last page of the addendum, included in this morning's news release.

Column A shows our Basel I capital ratios.

Column B shows our estimated Basel III ratios applying the rules effective as of January 1, 2013, to our balance sheet on June 30, 2012, and are calculated consistently with our disclosure of these ratios in prior quarters.

Our Tier 1 risk-based capital ratio was estimated to be 13.9%; our total capital ratio, 15.5%; our Tier 1 common ratio, 12.7%; and our Tier 1 leverage ratio, 6.1%.

For ease in the following discussion I will just refer to our Tier 1 common ratio unless otherwise noted, although Basel III will have an impact on all the ratios.

The Federal Reserve recently published 830 pages of notices of proposed rule-making, or NPRs, to implement Basel III in the United States.

Like our peers, we are still reviewing the potential impact of these proposals, and the table on the last page of the addendum and my comments reflect our best estimate as of June 30, 2012, of the impact of these proposed rules.

It is important to note that the rules recently proposed in the NPRs are not final, and once finalized, are expected to be phased in over several years.

The regulators have specifically asked for comments regarding the inclusion of the mark-to-market on certain available for sale securities and other comprehensive income for the purposes of calculating regulatory capital.

We intend to comment on this proposal.

Based on our understanding of the proposals, we believe that the simplified supervisory formula approach, or SSFA, that deals with the risk-weighting of securitized assets is expected to be implemented on January 1, 2015.

These proposed regulations have both positive and negative implications.

As written today, higher quality assets are being disproportionately penalized in that they receive a higher risk weighting compared to the previous Basel III proposals, moving from 7% to 20% or higher, depending on the securities.

In contrast, those securitized assets with lower ratings, such as those rated below BB minus, receive more favorable treatment under the NPRs than under the previous Basel III proposals, adjusting the risk weightings from 1250% to as low as 20%.

During the comment period, we intend to present the regulatory authorities the disproportionate effect of these rules.

In column C on the last page of the addendum, we display the estimated impact of these proposed changes to our Tier 1 common ratio under Basel III, including our estimate of the proposed impact of the SSFA as we understand it today.

These estimates are subject to change based on regulatory clarification and further analysis.

The implementation of the SSFA without giving effect to asset runoff in the investment portfolio or any management actions is expected to reduce our Tier 1 common ratio to 9.8%, approximately 290 basis points lower than the 12.7% ratio, as calculated prior to the recently-published NPRs and as shown in column B.

Column D shows our estimate of our Tier 1 common ratio after giving effect to both the SSFA and the investment portfolio runoff, and assumes reinvestment of $16 billion of relevant securitized assets.

As you can see, runoff alone is expected to bring the ratio back up to 12.0%.

Finally, Column E shows that management actions, if needed, are expected to lower our risk-weighted assets to approximately $96.2 billion and fully restore our Tier 1 common ratio to 12.7%.

Therefore, based on our current understanding of proposed rules, the net effect of the risk-weighting of the securitized assets under the SSFA after investment portfolio runoff and with the potential management actions is expected to be neutral to our Tier 1 common ratio by the assumed implementation date of January 1, 2015.

We believe that 10% continues to be a reasonable long-term target for our Basel III Tier 1 common ratio, using the same assumptions we outlined in our investor and analyst forum in February of this year.

This 10% ratio is the foundation for our 12% to 15% target range for our operating basis return on common equity goal.

In conclusion, while we saw signs of improvement in the US during the first quarter, that improvement seemed to slow a bit during the second quarter given the uncertainty that exists in the Eurozone.

We still face a low interest rate environment, new regulatory requirements, and increased compliance costs.

We remain focused on growing our revenue modestly, controlling expenses, and executing on our business operations and information technology transformation program.

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

And thanks, Ed.

Although we maintained business momentum through the second quarter, the increased weakening of global macroeconomics later in the quarter, especially the situation in Europe, leaves us with a cautious outlook for the remainder of 2012.

Our clients reacted to the uncertain environment by reducing risk in their investment choices, moving from US and emerging market equities to bond funds.

However, we did achieve positive net new business in the servicing segment of our business.

We're pleased that our business operations and information technology transformation program is on track with our plans and is contributing to the achievement of our 2012 goals.

Our capital position remains very strong, allowing us to return capital to our shareholders in the form of a quarterly common stock dividend, stock buybacks, and through strategic acquisitions.

We look forward to closing the acquisition of the Goldman Sachs hedge fund servicing business, which we believe will benefit our shareholders over the long term, and which enables us to expand our hedge fund client base in this fast-growing market.

Now Ed and I are happy to entertain your questions.

(Operator Instructions).

Glenn Schorr, Nomura Asset Management.

Just a quick wrap-up on the Goldman deal.

It makes plenty of sense strategically, in line with everything that you've done in the past, and you've got a lot of capital sitting around, so I get it.

I am sorry if I missed it, but did you tell anything about revenue earnings impact and any of the main assumptions you get to on the accretable in the first year?

No, we didn't report that.

We just reported it was some $200 billion in assets under management and 150 customers.

But just reported the conclusion, and on a cash basis, it's accretive in the first year.

Okay.

So I should stop trying on the assumptions, right?

I have a bunch of follow-up questions on that.

Yes.

(laughter)

Okay, cool.

And then on the Basel III, I think this got a lot of attention so far this morning.

I'm just wondering if you could oversimplify it for us.

Walking from the 12-7 to the 9-8 and back to the 12-7, in that great table you laid out, what are the securities that are getting the biggest increase in the risk weighting?

And is that just the runoff of them getting back to the 12-7?

And over what period of time do you get the bulk of that?

Yes, Glenn.

It is basically the effect that I explained in my comments, where the higher-rated securities currently -- we have a lot of AAA-rated securities that are adversely treated under this proposal, and they serve to increase our risk-weighted assets.

And offsetting that are some of the lower-rated securities, the ones that are currently subject to the securitization deduction under current rules, that actually benefit us from a risk-weighted asset perspective, okay?

So you have two opposing comments going on there in terms of the risk-weighted asset calculation.

And that is what is moving the ratio down to the 9.8%.

And conversely, going back up to the 12.7%, there's two things going on.

One, the portfolio runoff that is scheduled to occur between now and December 31, 2014, so another year and a half or so, before the -- I'm sorry, 2.5 years -- before the implementation date of [1/1/15], as well as, if we need to, potential management actions to get the ratio back to the 12.7%, which is where we started from.

I guess the main thing is, this is highly likely included in your CCAR plan and approved then, and you're not changing the way you conduct business.

I know I'm putting words in your mouth, but is that correct?

Well, it's not included in the CCAR plan that was just approved, because the rules have just been issued.

I would expect that it will be factored into the next CCAR.

But more importantly, the bigger point that you raise is right.

We're not changing the way that conduct business based on this.

We feel like we have ample capital, enough room to react to this if we need to.

Remember, the rules are proposed.

They are not final.

And a lot could change between now and implementation date.

Okay.

The follow-up on the Greek securities sale, and I apologize if I missed this too, but did you say what exactly they were?

Where they were held?

And if all the mark-to-market was taken this quarter?

I didn't, but I'm happy to go into it with you.

There were 5 bonds.

They were all RMBS.

They were held in our investment portfolio and held to maturity.

They totaled $91 million of principal amount, and we booked a $46 million loss on them.

It's a total exit of our Greek position.

We thought that given the uncertainty in Europe, and more specifically, the extraordinary events in Greece, that it was wise.

And we did this before the election on June 17.

It was wise for us to exit the position.

Got it.

And I take it you are assessing the other periphery of -- the securities held in the other periphery on the same basis right now?

Well, yes.

Obviously, there's still a lot of disruption in the Eurozone.

We have about $900 million of securities in the peripheral countries.

They are virtually all RMBS.

They are all performing well, with the exception of a handful of a couple of bonds that are on our watch list.

But we don't think the situation as it relates to those specific securities that we hold is anywhere close to our analysis of what we saw as the potential on the Greek position, which is why we sold the Greek position, and we still are holding the securities in the other peripheral countries.

Okay, no, that's very helpful.

Last one is, just curious --

Glenn, we really need to move along.

We have kind of given you a little bit of extra time.

But you get back to me, Kevin, Mallory later today, and we can be helpful.

Yes -- happy to get back on, Glenn.

No worries.

Okay.

Ken Usdin, Jefferies.

Just a follow-up on capital.

I just wanted to, from a big picture perspective -- you've got the NPR changes; 75 to 80 basis points also from the deal today; so as you look forward, does this at all change the way you're looking at the buyback?

Will you continue to pour through the buyback as planned in this year's allowable, and then will it change it all the way you think about capital return into next year, and acquisitions as well?

Yes, Ken, let me pick that up.

The proposed acquisition of Goldman Sachs hedge fund administration business will go through a regulatory approval process.

And we'll conclude based on that, the deal, hopefully in the fourth quarter, is our current plan.

I guess the point about the capital decisions -- I'd go back to their point in time.

We plan to continue to execute the buyback, but should other acquisition opportunities come along, we would evaluate those from a standpoint of shareholder return versus continuing to buy back our stock based on what's outstanding and where the stock is trading.

So our plan is to continue it, but it could be interrupted by other possible acquisition opportunities.

So that's my second question, was just related to -- you're talking about using 75, 80 basis points of capital on something that will be cash accretive but GAAP dilutive next year.

First of all, can you talk about when this deal will turn to GAAP accretive, and any magnitude if you can help us on that?

And then, secondly, how do you think through that -- deals versus buyback?

Is it, in fact, a trade-off?

I thought it was always supposed to be separate from however you think through your buyback.

And what changed?

Did something change with this NPR restatement?

Yes, nothing has changed in terms of our thinking relative to the NPR, Ken.

The deal on a GAAP basis is slightly dilutive currently.

It will turn to be accretive out in 2014, 2015, in that timeframe.

But the thinking has not changed.

You know, we're in a bit of a unique position, I think, in that the pure numerical analysis of buyback versus acquisition is somewhat constrained because of the CCAR and the plan that we have approved, okay?

So it's not a pure analysis of one versus the other.

The way we looked at this transaction was it made sense; it was strategic; it was opportunistic.

Obviously, it may not necessarily be -- been here in the future.

And we had a CCAR plan approved.

So we thought it made sense to do it.

Going forward, as I said before, it depends how the Fed factors the Basel III proposals, and I underscore proposals, into the next CCAR and what effect that has on any potential capital distribution next year, or any potential acquisitions.

Okay.

And then last little one just on -- other expenses was much higher this quarter versus last.

Anything you can point out in there?

And thanks for answering the questions.

Appreciate it.

Yes, sure.

Other expenses are really two things going on.

One was our securities processing costs.

When we're comparing a low quarter, Q1 -- actually, we had a credit for those securities processing costs, a small credit, but it's relevant to a higher level of securities processing expenses in Q2.

So you got that delta.

And then you have a ramp-up in professional services Q1 to Q2.

That is driven by two things -- one, these regulatory initiatives we're talking so much about.

We're spending money on professional services in order to evaluate them.

And two, the expenses associated with the transformation program.

Those also incur some professional services, some consulting costs.

So those two things are the drivers.

Okay, got it.

Thanks a lot.

Sure.

Howard Chen, Credit Suisse.

You're making really good progress on the long-term transformation program, but could we just get an update on the asset servicing competitive landscape, or the conversations on pricing changing, or the composition of what clients are asking for changing at all?

Sure.

Let me take a shot at that, Howard.

On the asset servicing, second quarter you saw that revenues were up 1%, let me just begin to frame the question.

S&P was up slightly quarter to quarter -- the EAFE average daily was down, I think, 7%.

So that performance was constrained by the market.

I'd say from a standpoint of market activity, pipeline, deal flow, pretty confident through the quarter.

I'd say that demand is high and pretty consistent from a standpoint of customer deal flow and prospect pipeline.

I'd say on the pricing point, which is the other point you raised, the longer this environment hangs around and the more constraining it is on some of our revenue lines, the more aggressive -- I say aggressive -- or the more formalized our plans are to make sure that we are capturing fair economics from our customers.

So we have a pretty broad-based effort underway across, obviously, only those customers that require some remediation to get the margin up to our target margin internally.

And have gone out to customers with requests for increases in fees, broader servicing relationships, in order to correct some of those situations.

So I would characterize that as more of a journey as far as the pricing environment.

From a standpoint of the competitive pricing environment, I would say it's mixed.

It's probably mixed by geography, mixed by asset class, but generally doesn't feel that changed from prior quarters.

Does that capture, Howard, the essence of your question?

Yes, that was very comprehensive.

Thanks, Jay.

And Ed, on the NPR, you focused a lot of your commentary on the risk weightings for securitized assets and the non-investment-grade securities, but putting those two elements aside, do you have any thoughts on some of the other factors that we heard about, including counterparty risk, and supplemental leverage ratio, and potential impact on you all?

Well, you know, our analysis so far on those other elements is ongoing, and our view is that a lot of them are immaterial to us, and net, probably don't have much of an effect on us.

The two things that I mentioned in the call are the ones we're the most focused on and think potentially have the most effect, which is the mark in OCI and the SSFA, Howard.

Okay, thanks, Ed.

And then final one, you both been really conservative about the FX outlook and what mix shift you might see.

I guess with all that said, I would have thought maybe we could see a sequential quarter-on-quarter lift given international dividend season.

Could you just put a little bit more content around what you already said in the prepared remarks, Ed?

Yes.

We saw both the sales and trading and the indirect FX both down sequential quarter.

It was across the board in both of the areas.

Indirect FX volumes were down a bit.

The FX sales and trading, which includes direct, was -- the volumes were up a little bit.

But overall, it was a quarter where it was tough in our FX business.

Okay.

And our FX business would be proportionately more tied to the core asset servicing business.

So some of the derisking or the lack of risking that went on with regard to emerging market investing and global investing, obviously, had a bearing on that.

Understood.

Thanks for taking the questions.

Thank you.

Brian Bedell, ISI Group.

Just one more on the Basel III.

I assume the ratio out to 2015 of 12.7%, that assumes no -- or I guess, what level of buybacks does that assume?

Is it really just at the second quarter share levels and assumes no buybacks, or do you have an assumption in there?

Continuing at the current rate.

Continuing at the second quarter pace through that -- to the end of 2014?

Yes.

Okay, that's great.

And Ed, going back to your comments on the revenue growth, and maybe this is a question for both Ed and Jay; so in terms of your modest revenue growth assumption, obviously, a little bit at risk with the environment being a little trickier.

What -- to what degree do you think the comp revenue ratio would be pressured?

Ed, you were saying, obviously, trying to get to about 39%.

If we have a more, say, flat to slightly up revenue year in 2012 versus 2011, roughly what would you envision the comp revenue ratio to be?

And then adding on to that, for Jay, if you can talk a little bit about client derisking at the end of the second quarter, if you think that is a material impact to third quarter realization rates in the servicing business.

Yes, I'll take the first one, Brian.

I mean, you know, we start off at 48.2% for last year's ratio.

We said we'd target 39.2% for this year, assuming modest revenue growth.

Now the first half of this year versus last year revenue growth is about 0.6%, so it's pretty modest six months year-to-date, which is why I said that if the second half is relatively weaker, the 39.2% target is going to be very, very difficult to achieve.

You know, it's hard to put a point estimate on it, but I would think we're talking about 39.5%, 39.6%, something like that, if revenue in the second half of the year is challenged.

We're not going to do anything relative to compensation just to hit 39.2% if revenue is not strong.

I mean, we have to balance out the needs of everybody -- shareholders, employees, etc., to make sure that we're maintaining the appropriate level of staffing for the business.

That is still year-on-year progress, so I would regard that as good.

And Brian, to your other question, the volatility here just continues.

If you think back to the first quarter, the first quarter started out slow, and then the back end of the first quarter, clients began to re-risk.

As we get into the second quarter, mid-point, the re-risking went to derisking.

So I just think we're cautious, because as we look out where we sit here, we have worries about the US, the election cycle, the fiscal cliff.

Europe is at times day to day; it's not week to week.

So we sit looking forward, saying, it's hard to envision a short-term scenario where there will be a shift back to re-risking.

That could happen, but we're not planning for it, which is why we make the cautious comments.

Right, that's helpful.

And then just lastly on the securities processing cost, Ed, can you frame how much that impacted the second quarter in terms of the higher level versus the credit in the first quarter?

In the range of $0.03.

Okay, that's helpful.

Great.

Thanks so much.

Alex Blostein, Goldman Sachs.

So wanted to go back to the capital question just one more time, I guess.

In previous discussions I think we talked about potentially the regulators looking at Basel III framework and little bit more in determining how it will allow banks to return capital in 2013 and beyond.

How does that change -- how does this revision change your view on whether or not you might be able to return to the same level of capital post this year?

Well, we don't know.

We have to see how the rules evolve, what the comments are.

I've outlined what we are planning on commenting on at this point -- the two big items I noted.

Then we have to see how the regulators factor these proposals, or maybe some revisions to the proposals, in their thinking about the next CCAR.

We just don't know at this point.

Okay, understood.

And then on net interest margin, and I appreciate the guidance you guys gave around some sensitivity to the back half of the year, but I guess looking at the balances, can you give us a little bit more granularity on maybe where the deposits sit with you guys, with which central banks versus -- it's the Fed or the ECB, just to get a sense of the sensitivity from here if there is further rate cuts?

Yes; they are mainly with the Fed, but they're also in part with the ECB.

And they can ebb and flow, Alex.

It depends where those deposits actually come in.

Right now the excess deposits are largely DDA in the US, so we're leaving them at the Fed, principally.

And then the last question I have for you guys is just on -- bigger picture on the margins, which if we look at over the last, call it two quarters, your pretax margin is in the high 20%s, call it 28%, 29%.

If you go back to when you announced the program, you were kind of in this high 20% range still.

It feels like -- call it $100 million of the program on a net savings basis is already in the run rate.

That's a good chunk, I think, of what the -- of the total savings that you've outlined.

But the margin hasn't really moved.

So I guess what gives us -- can you give us some confidence around that 400 basis points of margin expansion, given the fact that so far we really haven't seen any?

Yes.

Remember that we pegged that margin improvement off of the 2010 results.

And obviously, the world has changed since 2010.

The answer is a complex one, but I'll try to take you through it.

Because we break down how we think about the margin in terms of various categories to try to frame the changes from 2010.

So starting with the effect of transformation, we think we've gotten around 100 basis points of transformation.

This is June year-to-date 2012 versus June year-to-date 2011, so that is the relevant -- that's the right way, we think, to look at it, six months versus six months.

So there is 100 basis points of improvement there.

You have some one-timers which need to be adjusted for.

Those reduce the margin by about 90 basis points, so they roughly offset the effect of transformation right there.

And then if you look at the core business, which includes market impact, that's down in terms of margin about 1.5%, given the environment that we're operating in.

So those are the three broad buckets, Alex, that we look at in terms of the margin effect giving recognition to the achievement of the Ops in IT transformation savings.

Got it.

I guess said another way, if you look at -- to get to your 400 basis points of margin expansion, what did you guys assume for revenue growth the next few years?

We assumed various levels of revenue growth and just struck a number.

And it really didn't matter much, frankly.

We just assumed revenue growth grew at -- pick a percentage, Alex -- 5%, 6%, 7%, 8% --

5% a year.

10%, whatever.

And we also increased expenses at the same growth rate, not making any assumptions about operating leverage, okay, just to simplify things.

Obviously, we target operating leverage, and we say that every year.

But just for this model, bring expenses and revenue up at the same rate from 2010 and add in the $600 million savings, and then you'll see that approximately the margin increases by around 400 basis points.

It doesn't matter what revenue growth you take, as long as expenses grow at the same rate.

Got it.

All right.

Thanks for the color, guys.

Sure.

Vivek Juneja, JPMorgan.

A couple of questions.

Firstly, one small clarification.

Let me get that out of the way.

There was a securities loss in your reported earnings, but a securities gain in the operator -- can you just clarify why the difference and what causes that?

Sure.

We recorded the Greek exit as non-operating.

Our thinking there was that it was unique, extraordinary, given the circumstances in Europe, and particularly Greece.

And we exited the entire position in the country, Vivek.

So it's something that we think is more appropriately viewed as non-operating, given that our view of operating should be to give the reader a view of the core earnings power of the Company.

And I think if we're talking about exiting a position, or several -- five positions, specifically, in Greece -- and to classify them as operating, that would be, in my view, anyway, not the appropriate way to look at it.

In operating earnings, we have both purchases and sales -- some gains, some losses -- that are at the margin, if you will.

We've done those over time and we report them as part of the core earnings of the Company.

We had that this quarter, too.

Okay.

That's good.

That's an easy one.

Let's go back -- I want to go back to the buyback question that's been asked.

So looking at your 9.7% Basel III Tier 1 common ratio, that would be, I guess, 9% include -- if the acquisition were a pro forma date of June 30.

And you said you'd continue to buyback at the current pace that you had in the second quarter, you intend to continue that.

But if you do that, that would have no growth in the capital ratios, because essentially you bought back almost as much as you made in net income.

And given that your target at your investor day was to try and keep your Tier 1 common at 10%, can you reconcile how you get to 10% if you're going to be -- you know, when would you get to 10%, since I know you said there was going to be some runoff in securities, but clearly, looking back over the last few quarters, it hasn't run off that fast, that it has led to any improvement in the capital ratio.

Your Tier 1 common didn't really change if we adjust for OCI quarter over quarter from Q1 to Q2?

Yes, well, there's not much of an OCI effect, right?

But the growth from the 9.7% up to 10% and over 10% will occur over the next 2.5 years, from the midpoint this year to the end of 2014 as those securities that are subject to the higher risk weighting run off.

And so are these with the AAA subprime asset-backed that you have moved into your -- the part of the conduit that had been moved to held to maturity, that you're hoping will pay down over time?

Or does it come more in 2013, or is it more back ended?

Can you give a little more color?

No, it's not those securities at all, Vivek.

It is some of our actually higher-rated, we believe higher quality RMBS securities.

Some -- mostly foreign, that are driving the increase in risk-weighted assets.

And that is actually offset by a benefit on some of the securities that I think your question refers to.

Okay?

Some of the lower-rated securities, some of which we sold in 2010 in order to reposition the portfolio.

Those securities are actually benefiting in this calculation.

Okay.

So you're thinking that your 9.7% goes to 9%, and then you are still intending to stick to the 10% target?

Yes.

And 9.7% going to 9% is just layering in the Goldman Sachs acquisition in those calculations.

Right.

And how long do you think you get -- does it take for you to get back to 10%?

A year.

But certainly by the end of 2013.

Okay, great.

Thank you.

Brooke, we will take one more question.

Okay.

Our final question comes from Andrew Marquardt, Evercore Partners.

Just on the derisking commentary, it sounds like it wasn't fully reflected in this quarter's run rate.

How do we think about the go-forward implications from the de-risking stepping down?

And maybe put it in the context of what we saw last year, if possible.

Yes, it's a hard one to answer, Andrew.

I attempted to do that a few questions ago by talking about -- the first quarter had this same dynamic, which is the risking started slow, and then people re-risked in the second half of the first quarter, and now we've cycled back down again.

So I think you should look at it more from a go-forward perspective of the US and European markets and whether the confidence steps down again, or whether it remains where it is right now.

That's really what I'm signaling.

Got it, but it seemed like in the fourth quarter, even last year, I think that was maybe more reflective in the numbers.

Is that fair?

Yes, that is fair.

Is that how we should think about it going forward?

Or are we not there yet in terms of if you were to rank them, or put them in magnitude?

It's hard to give you a signal on that.

Okay, got it.

And then in terms of comp-to-revenue target, it sounds like modest revenue growth, less confidence in that now.

How do you guys think about modest?

What is the definition of modest?

And why even keep that target out there if there is less confidence?

Well, I have used the term modest, and the way that I've defined it, without putting a point estimate on it, Andrew, is to say, clearly, 60 basis points for six months, the first six months, or 1% or 2%, is not modest.

7% or 8% is above modest, okay?

So it is somewhere in between.

That was our thinking coming into the year.

But based on the first half results, that thinking is lower.

Okay.

And then just a ticky tack question on the processing fee line.

It came in at $48 million this quarter.

I know there was some noise last quarter, too.

How should we think about it going forward?

Is second quarter -- it is some of that nonrepeatable?

Or should we go back to the $70 million, $75 million-type quarterly range, or are we at -- resetting lower?

We're not resetting lower.

I'd say, again, it's tough to predict a line, but I think I've said in the past, $70 million, $75 million per quarter is probably a good number to use.

This quarter was significantly below that for a couple of reasons that I think I touched on in my script.

Got it.

And then the tax rate, just the last ticky tack.

Tax rate also lower.

Is it also reset lower, or should we also think about it going back to the 27%, 28%?

No, I think -- in the press release, I think we signaled that we expect 25% to 26% effective for the full year.

And that's a combination of two things.

One, the overall mix of revenue.

We're obviously getting some advantage there.

And then secondly, we have, and this is one of the benefits in the second quarter, a renewable energy investment which is generating some positive tax effects and will be for the full year.

Got it.

Thank you.

Okay.

Thank you.

I appreciate all your time this morning.

We look forward to speaking with you again after the third quarter.

Thank you.

Thank you.

This concludes the conference.

You may now disconnect.