道富銀行 (STT) 2013 Q1 法說會逐字稿

Good morning, and welcome to State Street Corporation's first-quarter 2013 earnings conference call and webcast.

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

This conference call is also being recorded for replay.

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

This call may not be recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation.

The only authorized broadcast of this call will be housed on the State Street website.

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

(Operator Instructions).

In the question-and-answer session, the Company has requested that you limit your questions to no more than two and return to the queue if you have follow-up questions.

This will permit multiple participants with questions for the management team to ask them on the call.

Now I would like to introduce Valerie Haertel, Senior Vice President of Investor Relations at State Street.

Thank you, Lisa, and good morning, everyone, and welcome to our first-quarter 2013 earnings conference call.

Our first-quarter earnings materials include a presentation that Jay Hooley, our Chairman, President, and Chief Executive Officer, and Ed Resch, our Chief Financial Officer, will refer to in their remarks.

Reconciliations of our non-GAAP or operating basis measures to GAAP measures referenced on this webcast, as well as other materials, can be found in the investor relations section of our website.

Before Jay and Ed begin their discussion of our results, I would 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 2012 annual report on Form 10-K and its subsequent filings with the SEC.

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

Any such forward-looking statements speak only as of today, April 19, 2013.

The Corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

Now, I would like to turn the call over to our Chairman, President, and CEO, Jay Hooley.

Thanks, Valerie.

Good morning, everyone.

Before I get started, I just want to acknowledge the horrific tragedy that has beset our great city this week, and just say that our thoughts and prayers go out to everyone that has been impacted through this event.

As Valerie noted, our remarks will follow the financial highlight slide presentation that we issued with our earnings press release this morning, and I will focus my comments on our operating basis results and primarily on the sequential-quarter comparisons, since those seem to be of most interest to you.

I am pleased with our first-quarter financial results.

State Street benefited from stronger-than-expected equity market performance, an increase in foreign exchange market volumes, and continued strong expense controls across the organization.

We continue to bring on new business and our pipelines remain strong.

If I take you to page 3, on an operating basis, first-quarter 2013 earnings per share was $0.96, which is a decrease of 14% from the fourth quarter of 2012 and an increase of 14% from the first quarter of 2012.

It is important to note that the first quarter of 2013 included the effect of $118 million pretax, or approximately $0.19 per share after tax, of equity incentive compensation expense for retirement-eligible employees and payroll taxes.

Our revenue was slightly higher than the fourth quarter and was 2% greater than the first quarter of 2012, driven mainly by improved equity markets, higher trading services, and new business, including the Goldman Sachs acquisition, offset by lower net interest revenue.

Our core fee revenue, comprised of asset servicing and asset management fees, increased about 2% to $1.4 billion from the fourth quarter of 2012 and more than 9% from the first quarter of 2012.

Importantly, we produced positive operating leverage of 130 basis points compared to the same quarter last year, due to our strong expense management.

And if you exclude the effect of the first-quarter 2013 equity incentive compensation expense for retirement-eligible employees and payroll taxes, we achieved positive operating leverage of 145 basis points for the quarter when compared to the fourth quarter of 2012.

Before I review some additional financial highlights, I would like to share some thoughts about the strong equity market performance in the first quarter and provide you some color on client investor behaving -- investing behavior.

As I previously discussed on both the fourth-quarter earnings call and at our analyst day in February, we saw signs of client re-risking at the end of the fourth quarter of 2012 and it continued as we began the year.

As the first quarter progressed, client risk-taking behavior moderated somewhat, but is still running ahead of prior years.

While the environment overall feels better, we remain cautious due to the ongoing fragile state of global markets.

As you are aware, the low interest rate environment weighs at our net interest revenue and, together with high levels of client deposits, our net interest margin.

At this point, the Federal Reserve continues to signal its intention to maintain low interest rates for the foreseeable future.

If I turn to new business, the first quarter of 2013 new asset servicing wins totaled $223 billion, which is comparable to the $233 billion in new wins that we reported in the first quarter of 2012.

Of the $223 billion in new asset servicing wins this quarter, about two-thirds were from within the US and one-third from outside the US.

Also included in our new business wins are 39 new alternative asset servicing mandates, a client segment that continues to present good opportunities.

With respect to the remaining installation of 2012 new assets to be serviced of $551 billion, approximately $70 billion remains to be installed in 2013.

Additionally, approximately $43 billion of the asset servicing mandates won during the first quarter had not yet been installed.

Among those clients installed this quarter are the US dimensional funds managed by Dimensional Fund Advisors, an investment manager with over $260 billion of assets under management through it and its affiliates.

We are providing a full range of services for this client, including accounting for US strategies, custody, and securities lending solutions.

This was a great competitive win for our US global services team.

Additionally, State Street Global Advisors' total assets under management increased 4% to $2.18 trillion in the first quarter, compared to the fourth quarter of 2012, driven by strength in the global equity markets and net new assets to be managed.

Within our ETF business, strong markets fueled a 5% increase in our ETF assets under management to a record $354 billion at March 31, 2013, compared to the fourth quarter of 2012.

Net client inflows were $5 billion in the first quarter, driven mainly by securities finance cash collateral pools.

We experienced net ETF outflows of $6 billion from both our Gold ETF, amidst declining gold prices, and from our S&P 500 ETF, which historically has outflows in the first quarter as institutions reposition their risk profile in the market.

These net ETF outflows were partially offset by a strong start to the year in Europe where we have been focused on expanding our ETF product offerings and inflows into SSgA's sector -- select sector ETFs in the US.

Looking ahead, our business pipelines in both asset servicing and asset management remain strong and well diversified.

Higher revenues in the first quarter, compared to the fourth quarter of 2012, were driven by strength in trading services, offset by lower net interest revenue.

And by the way, I have moved to slide 4 now.

In trading services, foreign-exchange trading revenue for the first quarter increased 24% to $146 million from the fourth quarter of 2012, due to higher volumes and increased volatilities.

Securities finance revenue increased about 5% in the first quarter from the fourth quarter of 2012, due to slightly higher volumes.

Our operating basis net interest margin was 131 basis points in the first quarter of 2013, compared to 136 basis points in the fourth quarter of 2012, partly due to the higher level of client deposits, which Ed will explain in a minute.

If I turn to expenses, we continue to control our expenses effectively across the organization.

Operating basis expenses increased about 6% in the first quarter from the fourth quarter of 2012.

Excluding the effect of the equity incentive compensation expense for retirement-eligible employees and payroll taxes in the first quarter, expenses actually declined over 1% from the fourth quarter.

And compared to the first quarter a year ago, expenses increased 1%.

Our business operations and information technology transformation program remains on track to deliver the highest level of pretax expense savings for the program of $220 million in 2013, and we continue to expect our transformation program to deliver approximately $575 million to $675 million in run rate savings for the entire program by 2015.

Turning to capital on slide 5, our financial strength and disciplined approach to capital management have enabled us to maintain consistently strong capital ratios under Basel I and the proposed Basel III standards, based on our understanding of the proposed rules.

As we reported in mid-March, the Federal Reserve did not object to our 2013 CCAR plan, which included our planned capital distribution program.

Following the CCAR results, our Board of Directors approved a $2.1 billion common stock purchase program through March 2014.

We completed our previously announced $1.8 billion common stock purchase program in February 2013.

Additionally, in February the Board approved a $0.02 per share increase in our common stock dividend, which is now $0.26 per common share, payable to shareholders this month.

So in summary, we are focused on creating value for our clients and shareholders, growing revenue, diligently controlling expenses, and distributing capital to our shareholders, which remains a top priority.

Now I would like to turn the call over to Ed, who will provide additional details on our financial performance.

Thank you, Jay, and good morning, everyone.

I will begin my comments on slide 7 of the earnings presentation, which shows a summary of operating basis results for the first quarter, and unless noted separately, I will be referencing only operating basis results.

Revenue was up slightly in the first quarter of 2013, compared to the fourth quarter of 2012, and up 2% from the first quarter of 2012.

The first quarter demonstrated our commitment to controlling expenses.

Expenses increased 5.7% from the fourth quarter of 2012.

However, excluding $118 million of equity incentive compensation expense for retirement-eligible employees and payroll taxes, expenses were actually down 1.2%, and we achieved 145 basis points of positive operating leverage in the sequential-quarter comparison.

Compared to the first quarter of 2012, we achieved 130 basis points of positive operating leverage.

Earnings per share of $0.96 decreased 13.5% from $1.11 in the fourth quarter of 2012 and increased 14.3% from $0.84 in the first quarter of 2012.

As you may recall, there were several items totaling approximately $36 million on a pretax basis, or $0.06 per share, that favorably affected our results in the fourth quarter of 2012.

The first quarter of 2013 included the negative impact of $118 million on a pretax basis, or approximately $0.19 per share, of equity incentive compensation expense for retirement-eligible employees and payroll taxes.

Return on equity of 8.9% decreased from 10.3% in the fourth quarter of 2012 and increased from 8.6% in the first quarter of 2012.

We purchased approximately $360 million of our common stock during the first quarter at an average price of $54.95 per share, resulting in approximately 463 million average fully diluted common shares outstanding during the first quarter, a reduction of 4.7 million average shares in the sequential-quarter comparison.

Now let us turn to slide 8 to discuss first-quarter operating basis revenue drivers.

Servicing fees increased 2.2% to $1.2 billion in the first quarter of 2013 from the fourth quarter of 2012, due to stronger global equity markets and higher transaction volumes.

Compared to the first quarter of 2012, servicing fees increased 9% due to stronger global equity markets, net new business, and the acquired Goldman Sachs Administration Services business.

Management fees at SSgA increased to $263 million in the first quarter of 2013 from $260 million in the fourth quarter of 2012, due to stronger global equity markets and net new business, partially offset by lower performance fees.

Compared to the first quarter of 2012, management fees increased 11.4%, primarily due to stronger equity markets and net new business.

Performance fees in the first quarter were approximately $4 million, down from $8 million in the fourth quarter of 2012 and up from about $3 million in the year-ago quarter.

Money market fee waivers were approximately $6 million in the first quarter, up from $5 million in the fourth quarter of 2012.

Total trading services revenue increased 15.6% compared to the fourth quarter of 2012, driven primarily by strength in foreign exchange revenue and electronic trading.

Foreign exchange revenue increased 23.7% from the fourth quarter, due to both higher volumes and volatilities.

Compared to the first quarter of 2012, foreign exchange revenue decreased by 2%, driven by lower volatilities, partially offset by higher volumes.

First-quarter 2013 electronic foreign exchange revenue increased 28% and 16% from the fourth quarter and first quarter of 2012, respectively, driven by an increase in volumes of 33% and 35%, respectively.

Securities finance revenue was $78 million in the first quarter of 2013, an increase of 5.4% from the fourth quarter of 2012, due to slightly higher volumes.

Securities finance revenue decreased 19.6% from the first quarter of 2012, due to lower spreads and volumes.

Securities on loan averaged $313 billion for the first quarter of 2013, a slight increase from $305 billion in the fourth quarter of 2012 and down 5.4% from $331 billion in the first quarter of last year, due to lower overall demand.

Processing fees and other revenue in the first quarter of 2013 decreased 18.3% from the fourth quarter of 2012, primarily due to a gain of $10 million from the sale of a Lehman Brothers related asset recorded in the fourth quarter of 2012.

Processing fees and other revenue in the first quarter of 2013 decreased 16.1% from the first quarter of 2012, primarily due to a $24 million positive fair value adjustment recorded in the first quarter of 2012 related to our withdrawal from the fixed-income trading initiative.

First-quarter 2013 net interest revenue of $577 million on a fully taxable-equivalent basis decreased 3.8% from $600 million in the fourth quarter of 2012, due to lower yields on earning assets.

Fully taxable-equivalent net interest revenue in the first quarter of 2013 decreased 4.9% from $607 million in the first quarter of 2012, due to lower yields on earning assets, partially offset by lower liability costs.

As we have noted, higher-yielding fixed-rate securities in our investment portfolio are maturing or paying down and being reinvested at lower rates, while floating-rate assets are resetting at market rates.

Our net interest margin declined to 131 basis points in the first quarter of 2013, compared to 136 basis points in the fourth quarter of 2012 and 152 basis points in the first quarter of 2012.

The decline in our net interest margin is the result of both a decrease in net interest revenue and an increase in average earning assets.

The increase in average earning assets is driven by the higher-than-expected levels of client deposits we saw in the first quarter.

If the current levels of client deposits continue for the full-year 2013, our average earning assets will likely grow between 3% and 7%, compared to the 2012 full-year average, and our operating basis net interest margin will likely be around the low end of the 130 to 140 basis point range, assuming interest rates, spreads, and prepayment speeds remain at their current levels through 2013.

This compares to our previous guidance of interest earning assets growing to a range between 1% and 4% and our operating basis net interest margin to be in the range of 130 to 140 basis points.

Turning to operating basis expenses on slide 9, in the first quarter we continued to control expenses.

Compared to the fourth quarter of 2012, we reported negative operating leverage of 544 basis points.

However, excluding the effect of expenses related to equity incentive compensation for retirement-eligible employees and payroll taxes, we achieved positive operating leverage of 145 basis points.

Compared to the first quarter of 2012, we achieved positive operating leverage of 130 basis points.

As you can see on this slide, compensation and employee benefits increased 13.1% in the first quarter of 2013 from the fourth quarter of 2012, due to the effect of the $118 million of equity incentive compensation expense for retirement-eligible employees and payroll taxes.

The first quarter of 2013 included the impact of the targeted reduction in force we announced on the fourth-quarter earnings conference call.

To date, we realized approximately 10% of the expected $90 million in annual savings, which is on target with our plan.

Compared to the first quarter of 2012, compensation and employee benefits expense decreased 2.7%, partially due to the savings associated with the execution of the business operations and information technology transformation program.

First-quarter 2013 information systems and communications expenses increased 1.3% and 24.1% from the fourth quarter of 2012 and the first quarter of 2012, respectively.

The increase in both periods was due to costs related to transition activities in connection with the business operations and information technology transformation program, as well as costs to support new business.

These expenses are expected to increase slightly over the next few quarters and then level off.

The business operations and IT transformation program continues to be on track.

For 2013, we expect to achieve approximately $220 million in incremental pretax expense savings, resulting in approximately $418 million of cumulative savings.

Consistent with our initial forecast of the entire program, we expect to achieve run rate pretax expense savings in the range of $575 million to $625 million by 2015, compared to year-end 2010, all else equal.

Our nonrecurring expenses related to the business operations and IT transformation program were approximately $25 million for the quarter.

We expect these nonrecurring expenses to trend lower this year and in 2014 as we near the completion of the program.

Lastly, other expenses decreased 7.9% from the fourth quarter of 2012, driven by lower professional fees.

Recall also that the fourth quarter of 2012 other expenses included a $14 million one-time Lehman-related client recovery recorded in that quarter.

Now let me give you some details on our investment portfolio, including some highlights from the first quarter.

As I outlined in the top half of the slide, slide 10, the key elements of our strategy remain unchanged.

Our investment portfolio decreased slightly to $116 billion as of March 31, 2013, down from $120 billion as of December 31, 2012.

We have a solid credit profile with approximately 88% of our portfolio securities rated AAA or AA.

The duration of the investment portfolio was 1.7 years as of March 31, 2013, unchanged from December 31, 2012.

We will continue to manage the portfolio with a target duration of around 1.5 years, but there will be periods of time where we are slightly above or below that target, depending on our investment priorities.

As of March 31, 2013, 54% of our investment portfolio was invested in floating-rate securities and 46% in fixed-rate securities.

The aggregate net unrealized after-tax gain in our available for sale and held to maturity portfolios as of March 31, 2013, was $817 million, compared to a net unrealized after-tax gain of $698 million as of December 31, 2012.

The improvement in the quarter was due primarily to narrower spreads.

During the first quarter, we invested about $4.5 billion in primarily AAA-rated securities at an average price of 101.22 and with an average yield of 1.05% and a duration of 1.82 years.

Of the $4.5 billion, we invested approximately $3 billion in both US and non-US asset-backed securities, and the remaining investments were spread among various asset classes.

The duration gap of the entire balance sheet as of March 31, 2013, was 0.41 years, up from 0.36 years as of December 31, 2012.

The increase was primarily in response to a steepening of the treasury yield curve from two years to 10 years.

Turning to capital, slide 11 has a summary of our strong capital position.

As of March 31, 2013, our Tier 1 common ratio was 16.1%.

Our estimated pro forma Basel III Tier 1 common ratio under the Basel III NPRs, as we currently understand them, was 10.6%.

Also as of March 31, 2013, the estimated pro forma Tier 1 common ratio under the Basel III NPRs, including estimated effects of schedule runoff and anticipated reinvestment of the securities affected by the SSFA through January 1, 2015, was 11.4%.

Note that the Federal Reserve's rules implementing the Basel III capital requirements, including underlying capital models, are not yet final and are therefore subject to change, and that the finalization of these rules may result in changes to our projected Basel III ratios.

Our capital distribution plan reflects our strong capital position.

As a percentage of 2013 consensus earnings, State Street's capital plan is the highest of the 18 bank holding companies that participated in the 2013 CCAR process.

So to summarize, solid first-quarter results were supported by increased total fee revenue over the fourth quarter and a continued commitment to prudently manage expenses.

We continue to expect the effective tax rate on an operating basis for the full-year 2013 to be generally consistent with the last two years, in the range of 23% to 25%.

Finally, and importantly, we will continue to optimize our strong capital position and expect to return capital in the form of common stock purchases and dividends.

Now I will turn the call back to Jay.

Thanks, Ed.

Let me briefly close our call with three points.

First, in the first quarter we delivered good results amid rising equity markets and a persistently low interest rate environment.

We continue to aggressively manage our expenses while maintaining the high quality of service to our clients.

And we remain confident in the secular trends that underpin the prospects for growth in our business, and I believe that we're focused on the right value drivers.

With that, Lisa, we will open the call to questions.

(Operator Instructions).

Howard Chen, Credit Suisse.

Thanks for hosting the call.

I know it is a challenging week up in Boston, Jay.

My first question is a question of balance sheet size, Ed.

Just given all the puts and takes to begin the year that you and Jay walked through, I was just hoping you could comment, from where you are now, what would you characterize as seasonal and frictional, rather than the impact of new core business installation?

That is a little hard to say.

I think it is a combination of clearly some new business, but it is also, I think, a combination of the world being fairly awash in liquidity.

I think we are seeing some of the customer deposit flows because of that -- because of both factors, really.

We saw average deposits up about $6 [million] over Q4, and TAG had the effect of bringing deposits down about $7 billion, which was in line with what we expected.

So we are seeing, I would say, more liquidity, a greater increase in Europe.

The non-US deposits are, we think, awaiting reinvestment.

And I would say that that's probably in the temporary category, to your question.

What in the US we are seeing deposits up around $1 billion, but that is net of the TAG outflow, so we've seen about $8 billion of USD inflows.

We are also seeing another trend, a little bit of a trend, I guess, where the US deposits, half of them are coming into interest-bearing accounts, which we think is, again, a reflection of excess liquidity being available in the marketplace, hopefully awaiting reinvestment, but looking for some investment that is, obviously, safe and relatively market yielding.

Great, great, thanks.

And then, shifting over to securities lending, I realize the business isn't as large as it used to be, but we saw a seasonal lift, but maybe not as much as we have seen in the past.

Could you just talk through your current outlook for that business and maybe latest thoughts on some of the rule proposals we are hearing out of Europe?

The seasonal lift, Howard, you mean the dividend season?

Is that what you're --

No, I just meant 4Q to 1Q.

I know that we usually see a bump up, Jay, just with the new year.

Yes, I think there is some bump up, although, as you know, the dividend season, which is the real cyclical high quarter, is about to come on us in the second quarter.

But I would say, generally, securities lending balances have stabilized in the low 300.

I think if you look at quarter to quarter, year over year, the effect of the downward pressure on revenue has been largely the Fed fund to three-month LIBOR rate.

I would suggest that the business is in a stable state, I think waiting for a pickup in merger and acquisition activity, which would have a positive effect on that, and further leverage in the general financial services system would be catalysts for growth, in addition to any widening of spreads.

Okay, and then the second part of the question, Jay, just thoughts on the rule proposals coming out of Europe.

Any latest views?

You know, I think it is too early to tell.

I think that there is a number of things that are circling around securities finance, but our outlook is really unchanged as far as the business continuing to be a good business for us over time.

As the rules firm up, that may change, but no view as of today.

Okay, thanks for taking the questions.

Robert Lee, KBW.

First question I have is, I'm just curious, if I look at the assets under custody and administration, and clearly you have had some tailwind of favorable markets and new business, but the pension assets -- the pension products there have been relatively flat for several quarters, and I'm just curious.

Can you address, maybe, what kind of mix you are seeing?

New business wins coming mainly in fund products and maybe it is the pension clients where you are seeing some runoff of clients or business?

Yes, it is a real mix.

This quarter, which was -- I think last year we had total assets, new assets serviced of $1.2 billion.

This quarter, it was $230 [billion].

So kind of an in-line quarter from a longer-term trend standpoint.

Two-thirds US, one-third non-US, that is a little bit different than what we have seen in the past.

But I guess more to your sector question, pension's kind of stable.

We have had some good new business wins there, no losses that I am aware of, so a net positive.

But as you know in the pension segment, it's a pretty stable segment.

Most of these are DB-oriented funds that aren't getting new flows.

So on the other side, broadly, the funds business, US and non-US, obviously benefits from flows and all the things that happen when clients re-risk.

And that pipeline and the successes have been very good.

And as you know, in many markets, including the US, we're a little bit of a significant market share leader, and I think we continue to gain on that leadership.

I'd just draw a little bit of a line under Dimensional Fund Advisors, which is a very significant US-based, but with global products in the asset management space, and converting that business this quarter was a big win for us.

And we would hope they will continue to succeed, and with their success we will benefit from it as well.

So, again, pretty diverse SPDR.

The only other segment that I would call out would be the alternative segment, which, and you see this in broad-based flows, or asset growth, the alternatives continue to grow.

And for us, the growth is twofold.

It is -- we grow as the funds grow.

We grow as we competitive -- we are successful in competitive new business wins, but also a good deal of that, particularly private equity and real estate segment, is yet to outsource.

So that is why I continue to call that out because that should continue to be a ripe area for growth for us.

Okay, thanks, and maybe just my follow-up thread.

This is a question, and possibly it is not that big a deal and may be hard to quantify, but I'm just curious.

I know probably in the ETF business and some of the funds business and maybe even net interest revenue, there is a little bit of an impact from day count, just there being a few -- couple fewer days in the first quarter.

Is there any way of quantifying what that impact is on revenue at all?

Yes, there is.

We think about that, frankly, more from the perspective of net interest revenue.

I don't have that number at my fingertips, Rob, but absolutely there is an impact in terms of day count.

We're looking for the number now.

I don't know if we have it immediately available, but I could certainly follow up with you after the call.

Great, that would be great.

Thank you.

Ken Usdin, Jefferies.

Ed, I was wondering if you could just talk a little bit about just on the servicing line side, did you have any negative impact from FX translation this quarter?

And can you -- Jay, I heard your comments about starting re-risking in the beginning of the quarter and then a little bit of tailing at the end.

But what were the core drivers of the servicing line?

It certainly was up nicely, but not as much as it seemed like people were looking for, so what were the key drivers?

Yes, let me start that, Ken, while Ed is looking for a number here.

So up -- servicings were up, I think, 2.2% sequentially, 9% year over year.

So, a good year-over-year growth, decent sequential growth.

You will also note that the first quarter is a pretty big installation quarter for us when you think about what was left from last year and what we installed that we committed in the first quarter.

So I think on the re-risking, Ken, if I were to walk you through a monthly scenario which largely mirrors what you see in the US mutual fund industry, we exited last year.

December was a peak quarter.

That traveled through January, February, and March tailed off a little bit, but still running stronger than we have seen in prior years.

So I guess the other little nuance would be that as opposed to a rotation, which flows out of fixed income and into equities, it has been more coming out of cash products, and I suspect not just money funds, but other bank cash products, has been fueling a little equity run that we have had here.

So it has been a tumultuous couple of weeks here in the global environment.

We will see what -- how the rest of the quarter plays out, but it does feel a little bit different than years past with regard to some level of resiliency in investor behavior, even though we have come off of the peak of the December/January months.

Yes, and Ken, the answer to your question in terms of currency effect on total revenue, it is fairly immaterial.

It is about $10 million down, sequential quarter, and $14 million down year over year, first quarter to first quarter.

So, not much.

Got it.

And then, my second question, just a similar question on the asset management fee side because there you did see also positive flows, positive AUM growth.

I was just wondering, was there any delta in either performance fees, or why did that line not grow more sequentially, given the better backdrop and the AUM growth?

Yes, so that was sequentially -- it was fairly muted year over year, up 11%.

The flows within the story would be positive on the securities finance-led cash collateral pools.

The FX -- the ETFs was a little bit of a mixed story.

So we had -- as we have been telling you, we are creating and innovating new products in Europe and the US.

We saw some good growth in Europe, but the offset was you have seen gold prices and therefore we have seen some outflows into gold.

So that was a little bit of a negative on the ETF side.

And you also -- we typically see year-end a little bit of a run-up in the S&P 500 ETF, which came off in the first quarter.

So those are the quarter-to-quarter trends that occur.

I would point you a little bit to the 11% year over year and say that we feel pretty good about how that business is progressing.

We think we are in some of the sweet spots of the market, passive and ETFs in particular, albeit there was a little bit of a muted quarter-over-quarter growth in management fees.

Okay, great.

Thanks a lot, guys.

Glenn Schorr, Nomura.

First one is just a quickie on the average balance sheet.

The biggest driver, I think, on the NIM decline is the decline in the other investment line.

Just curious, [down the aa] what, 16 basis points quarter on quarter, just curious what is producing the biggest drop there.

Those are loans we have out to custody clients, collateralized loans that are driving that, as well as our BOLI investment, non-portfolio assets.

Is it just utilization that's the biggest driver of the movement (multiple speakers) -- because it --

Yes, it is episodic.

It is episodic, but it is episodic in size, but also you are saying the runoff, and that just pushes the yield down.

Yes.

Okay.

Other one was just curious if you can frame, even in round numbers, what the Goldman acquisition added to revenues, expenses?

And thoughts, early thoughts, on client and revenue retention thus far?

Goldman is -- the acquisition is progressing right on track.

We announced it and said it was about a $120 million annual revenue business with a margin in the range of 30% to 35%.

And it is right on track.

And in terms of client revenue retention, we are exceeding the 90% target that we put out for every acquisition that we do.

So, nothing but good news on the Goldman Sachs Administration Services acquisition.

Okay, that is good, and it sounds like it might have been a modest contributor to the pos operating leverage, but the core is still there and good?

Absolutely.

Awesome.

Right on both counts, Glenn.

Perfect, that's my two.

Thanks.

Brian Bedell, ISI Group.

Just to go back to the core servicing line, Ed, you mentioned $10 million revenue impact from foreign currency translation.

Is that mostly in the servicing line?

And then, if you could talk a little bit about the pace of installations.

You installed the large DFA business during the quarter.

And inclusive of the other installments from the very strong fourth quarter, should we expect a lagging benefit as we move into the second quarter on the servicing line?

It was, as I mentioned earlier, a pretty strong installation quarter, given the tail of what was left from 2012 and the implementing a good deal of what we committed in the first quarter.

In the case of DFA, not completely installed, but a good chunk of it installed, and should layer in, I think, through the course of the second quarter.

So all else equal, yes, we should see the benefits of that roll forward as we move through the year.

Okay, great.

That is helpful.

And then, my follow-up will be just on the balance sheet investment strategy.

I know -- I think you highlighted a 1.05% reinvestment yield.

It is a lot lower than the fourth quarter, I guess.

Is there any change in strategy in terms of trying to shorten the duration or improve the credit quality that is driving that compression?

I know yields are down in general, but that seemed like a larger drop than I was expecting for the reinvestment.

No change in strategy, Brian.

We are of the same mind that we have always been, which is investing through the cycle and keeping the portfolio in the range roughly 50-50, fixed rate and floating rate.

And it is just a question of the market opportunities that we saw in the quarter.

So no change there.

Back to your earlier question, about a third of that $10 million effect is in the servicing fee line for the quarter.

Okay, that is helpful.

Thanks so much.

Alex Blostein, Goldman Sachs.

I was hoping you could help us reconcile, I guess, what you're seeing as far as the environment and what is going on with the servicing business, I guess, versus what we are seeing, which is the revenues.

So Jay, I guess on the one hand you described a little bit of a better risk appetite environment and clearly better markets, and it seems like the [middle] office in the alternative solutions continue to win a larger share of total business, which again feels like all should result in a higher fee rate, yet we haven't seen that and it doesn't sound like in the near term that is going to improve.

So I was hoping you could help us reconcile that, and maybe it's the other part of the business that is maybe seeing more pricing pressure, or the business that you guys are winning doesn't seem to be all that different from a pricing perspective relative to a core fee business.

Yes, I think that is -- that's a multi-headed question, although I do -- I continue to remind you of the sequential quarter versus year over year where there was good service fee growth.

So I think some of this can't be read into a specific quarter-to-quarter comparison.

But generally speaking, the environment, I think the pipelines are good and I think that is a reflection of, in the asset management world and the alternative world and in the pension world, the asset owner world, clients are continuing to outsource more work to us.

We continue to do better than hold our own with regard to on the competitor front.

We are continuing to introduce new products to differentiate our service offering.

And in concert with that, the pricing environment, I don't think it has changed much, but we have become more disciplined with regard to bidding for new business, with regard to making sure that we are extracting a fair economics from our customers for the value that we are providing.

So I think that begins to frame it.

I think the risking behavior, as I said, has been episodic, but better than last year, and I think if you look at the year-over-year 9% increase in servicing fees, some of that is reflective of a better risk environment.

I think that the thing that we are all waiting for and hoping for is that this follow-through, not only on the move to equities, which we have seen some evidence to, but at some point you're going to see flows come out of fixed income into equities, and I think that given our position, particularly in the asset servicing for asset manager space, we have expectations that that is going to be a good thing once that starts to happen.

Hasn't happened yet.

Got it.

Thanks for the additional color.

And then, just wanted to go back for a second on the ETF activity we're recently seeing with your business.

It seems like first -- second quarter to date, total AUM is down in the $14 billion-ish range, and a lot of it is yield driven.

I was hoping you could maybe give us a sense of on a net basis, what does that do to your earnings?

I know it is not big numbers, but I think the fee rate that you guys collect on the actual management is a little bit higher relative to what the net impact is because, I guess, of some of the expenses.

But just help us understand that $14 billion of outflows you show in the ETF business, what the net impact of that could be?

So begin with, not really material, but if you look at that GLD product, we share management fees with the Gold Council, and I think we are in a 14 basis point-ish range for what we -- the revenues that we derive from that, so that gives you a little bit of a sense of the dimension of the effect.

Got you.

So not big numbers, great.

Thanks, guys.

Mike Mayo, CLSA.

I see on slide 7 of the presentation, you are now including the pretax operating margin, so I see that increased -- I know it is a focus.

But I like the extra presentation, and that is my question.

So if you back out the accelerated options expense for the quarter, that pretax operating margin on page 7 goes from 26.6% to what?

I guess it does to 31%?

Is that correct?

About right, yes.

And then, your goal, as pointed out, I think it was slide 36 from your Investor Day presentation, you talked about the core margin in 2010 of 27.5%.

Your goal is to improve that by 400 basis points, so your goal is 31.5%.

So if it's 31% core this quarter and your goal is 31.5%, and then if you have about $400 million of additional savings from the IT project, all in if it drops -- just reduce expenses and that is it, I get a number of 35% pretax operating margin.

So if you can correct my math or if you can caution us about potential headwinds you're concerned about as for the reason not increasing that target?

We put the 400 basis-point margin target out there, Mike, predicated on 2010's results.

And caveat it by saying all else equal, and obviously all things are not equal.

It is always a little bit dangerous to take a quarter and project it out over a multi-year program.

I can't disagree with the math you ran through in terms of if you exclude $118 million of expense from the quarter, the margin would be higher.

But, however, that expense would have to be recognized over the succeeding quarters and years.

Our normal amortization period is the vesting period for those awards, so the expense would be over the next 16 quarters, okay?

So you have to recognize there are some moving pieces here, and to look at the first quarter and say we are already at or close to our program target is, I think, a bit of a leap.

Now we are not signaling by that answer that we think the target is not achievable.

We believe we are going to get the $575 million to $625 million out of the expense base, but that is going to occur over time, and we would expect the margin to improve over that period of time in line with what we originally said, not looking at just the first quarter.

Okay, well, just making that one adjustment, if we spread that over a quarter, so that 31%, I guess, would be 30% for this quarter and 34% once you have all the savings, just by the math.

So my follow-up question is, your goal is to become the low-cost producer.

What would you perceive as a pretax operating margin for the low-cost producer in the processing business?

We have been reluctant to put a number out there for what the low-cost producer is or an operating margin target, other than to quantify what we think the effect of the program will be on the margin.

Again, all else equal, predicated on 2010.

Clearly, we think we are making good progress on the project.

Clearly, we think we're improving the margin.

I think you can see that through the first nine quarters of the program and its implementation.

But to date, we have not put an operating margin target out, other than what we have said about its effect on -- the program's effect on the margin.

Mike, the other thing I might add to that is we do aspire to be the low-cost producer in those activities that have become more standardized and commoditized in the business.

And we think that our IT and ops transformation program is aimed right at that.

Additionally, by layering in the cloud environment, we also think we'll be able to be a lead producer of new products and new capabilities in this business.

So the goal is really to make sure on those core activities that we do have the lowest unit costs in the marketplace, but we are continuing to invest through the cloud environment to make sure that we're differentiating our products so that we can have pricing power on the other end.

I mean, that is the magic combination is to be -- have the lowest unit cost, but also be the most effective innovator on the product side.

We think that is the best combination for us going forward.

All right, thank you.

Luke Montgomery, Sanford Bernstein.

You were targeting NIM of 1.3% to 1.4%, now you are pointing to the low end of that range.

It is only Q1; you are already at 1.31%.

So I'm trying to gauge your confidence that you can maintain that guidance going forward.

We are pretty confident, Luke, that if, in fact, the assumptions that I articulated relative to portfolio size and balance sheet size and customer deposit levels, prepayment speeds, et cetera, playout, that we will be able to hit within that guidance.

And remember, we are talking about our expectation for the year being a net interest revenue decline in the range of $150 million versus 2012.

So we are confident that we will be able to do that, given those assumptions.

Okay, thanks.

And then, I wanted to return to Alex's question on middle office, given your commanding market share there, it doesn't seem to be a commodity service at this point.

So it is sometimes confusing that you have communicated that the fees you charge for that don't look much different from the back-office outsourcing.

You've said you're getting paid fairly for the value you provide, but can you just remind us why you can't charge more for this suite of services?

Yes, Luke, we don't, in any single instance, offer middle office servicing as a standalone.

So it is -- I view it as it is an enhancement to our overall bundle of services, and you're right to point out that we have a significant market leadership in that, which translates into when we are competing for new business, we do well.

We compete very effectively because we have the best capabilities.

And the more differentiated you are at the point of sale, the more you can hold price.

So I think that is how that translates.

I think in very complex opportunities that have a middle-office component, we are highly successful where we are -- where we really want to win the business, and pricing is pretty good because we are differentiated.

Great.

Thanks for taking my questions.

Cynthia Mayer, Bank of America Merrill Lynch.

Maybe one micro question, one big-picture question.

The micro question is just on expenses.

The drop in other category was really noticeable, even apart from the unusual expense in 4Q.

So you guys mentioned professional fees as the main factor in that.

Is that a sustainable level or would that bounce back seasonally or with some projects that you plan?

Our focus has been very significantly on that line, among others, but in the fourth quarter to first quarter decline, we did have a lower level of professional services.

We are not expecting the professional services spend to bounce back to what was in prior quarters, but it may increase somewhat, depending on the situation.

Okay?

There are consulting costs in there, for example, for evaluation of regulatory initiatives, things like that.

So there may be some increase in the future.

Maybe it is more of a timing question to some of these expenses from -- that went down in the first quarter, but it is absolutely a line that we are looking at very hard and we are trying to make sure that we do not see a rebound in that expense line above what we think is absolutely necessary to comply with regulatory initiatives, for example.

Okay.

And then, bigger picture, you mentioned your focus on growing your ETF business in Europe, and I'm just wondering if you could give some color on that.

Talk about, are you targeting certain market share, certain parts of that market, certain products?

What is your strategy over the next few years to be bigger in Europe?

And I would add to that, Cindy, Asia as well, but a little bit more focused on Europe.

So the strategy is to participate in an evolving market opportunity, and I do think when you look at the ETF business globally, the world is -- Europe's underweight in ETFs, and so we are starting to see those opportunities unfold.

And I would say that the way we get at that is really twofold.

One is through introducing differentiated product to the market, so we have introduced, I think it is, 40 products over the last 18 months.

I would say creative and innovative products which are commanding higher fees, so part of our strategy is to not be as much in the commoditized end of ETFs, but be in the differentiated end, a large part of which revolves around the portfolio strategy.

But equally important, and sometimes not understood, there is a distribution end to that.

So the distribution in Europe is largely through private banks and other intermediaries, and as a result we have added wholesalers and distributors in Europe.

So that is part of the buildup.

I think that is largely in place, so it comes to continuing to introduce new product and distributing it through those wholesalers.

So we think the opportunity is emerging and we think we are well positioned for it.

And I would say Asia is a story that is a few innings behind that whole story, but the same thing should unfold.

Okay, thanks.

Brian Foran, Autonomous Research.

I guess -- I hope this doesn't come across as too simplistic a question, but if I just think about 30 years of [trusting] data, not just you, but the whole industry, it just seems like the operating margins have always been about the same level, and I guess if you step back and think about these as scale businesses and all the investments in technology, why isn't there, at some point in the future, a step change up in operating margin?

It just seems like for a lot of investors, maybe part of the frustration with the whole industry, certainly not you alone, is the benefits of scale never seem to have accrued?

Yes, so let me take a swing at that, Brian.

I think for a long period of time, decades, these were growth businesses where markets were growing, new products were being introduced, and there was plenty of opportunity to grow topline and there was enormous need to invest, infrastructure, domestically, globally, product wise.

I think part of that run-up on the revenue side introduced market-driven revenues to that mix.

And then, if I just pick a point in time in the last five or six years post crisis, market-driven revenues have declined for all the reasons that we all know.

We have all been working on, I would say as an industry, adjusting to a lower growth environment, which means -- my interpretation, it means we need to get more efficient.

We need to be that low-cost producer in that core activity.

Yet there is still an enormous need to invest in the business.

So I think we are -- for State Street, I would say we are working through a period where we are adjusting to a low growth rate, which we think is more temporary than permanent.

As a lot of things that we spoke about change in the environment, whether it is re-risking or some of the market-driven revenues improving -- point to NIR as just a specific and important one, as we get our infrastructure more designed for a lower growth environment, and the environment changes and we stay disciplined on the cost side, then we think we can change the mix going forward.

So I think that is a little bit of where we have been, and I think the transition of what we are doing in this period is trying to become -- is becoming more efficient, more effective, while still investing in the business.

We think that at some point it will cycle out and we will see improved environment, and we will be in that improved environment with an improved infrastructure.

So that should give us the opportunity to generate more returns, which we'll bring to the bottom line and invest to further distance ourselves from competition, would be my streaming thought on that.

Thank you for that, and one follow-up on OCI.

Do you think, as we move forward with Basel III ratios and maybe with a rate back-up scenario and future stress tests, OCI will change in any way the potential for buybacks in the future?

And within that, do regulators think about OCI on short-duration securities books the same way they do on longer-duration securities books?

It just seems like even in a severe interest-rate stress scenario, a lot of the OCI risk in your portfolio would fix itself in a year or a year and a half?

Yes, I don't know exactly what the regulators think.

I tend to have a view that OCI is OCI at this point.

It doesn't really get differentiated between longer-term and shorter-term securities, at least we haven't really heard anything to that effect.

The issue of OCI on a go-forward basis and its potential effect on buybacks, there is information submitted as part of the CCAR which does include Basel III-related information.

The official test and the statistics published are Basel I, but the regulators do view our balance sheet under a Basel III regime.

So the mark, obviously, in the Basel III capital ratios is included.

I think, too, from our perspective, the potential for its inclusion on a go-forward basis with the rules not yet being final, Brian, is one of the main reasons why we put a 200 basis-point cushion on top of our 8% requirement, which includes our SIFI buffer.

It is because of that uncertainty, in part, that we've done that.

So I guess the punchline is that we need to see what the final rules ultimately are.

And we will look at those and formulate a view on what our Basel III Tier 1 common target going forward should be.

Great.

Thanks for taking my questions.

Betsy Graseck, Morgan Stanley.

Just a quick question on the cost saves from the cloud investment.

You are expected to have about a $220 million benefit to earnings this year, and I am just wondering how much of that was used up this quarter.

We achieved about $50 million of the $220 million for the year.

I think a linear view of that achievement is what we expect and would expect to see roll through the succeeding quarters of the year, Betsy.

Okay, thanks.

Josh Levin, Citigroup.

With all the work you have been doing on expenses, how much of your core cost structure would you say is fixed versus variable, and how would that compared to maybe one or two years ago?

Again, it is always a question of over what time frame, Josh, right?

And I think that probably the best way to think about it is over a relatively short time frame, i.e., a couple of quarters, maybe a year.

And we can look at a couple of different lines on the income statement and talk about them in terms of how much is fixed and how much is variable.

The largest one, obviously, is the compensation line, and that is a function of how many people we have, and we've been taking action on that line over the last couple of years, given what our view of the revenue environment is.

So you could say at least a portion of that is variable, given the assumption of a year or so timeframe.

I think that the other line that we've been looking at very carefully over time is the other expense line.

Some of that is actually not really very variable, given that there is some amortization of intangibles in that line, for example, which are based on prior acquisitions, but there are other expenses as we had in the first quarter that are, in fact, variable, which are the professional fees that we had a very good performance on, as we have noted.

And then, maybe in between that is transaction processing, which can vary with market levels and transaction volumes.

Usually we have offsetting movements in revenue, so it nets to a profit.

If the transaction servicing line goes up, there is a revenue item that is up more than that, and the converse is also true.

But I would say overall it is an expense base which over the short to intermediate term, while has some variability, is for the most part a fixed-cost expense base.

I would be hesitant to put a percentage on it, but that is how we think about it.

I would put another statement out there, which is our IT expense, which is both people and machines and licensing fees, and we can move that over time and I would say over, again, the year's timeframe between the operating range of 20% to 25%, which is what we target of expenses.

So that is a number that is in the range of $1.4 billion per year.

That includes people.

So that can be moved around, and that is a function of demand and regulatory imperative, certainly lately, and the need to continue to invest in the business and develop new products.

Okay.

A week or two ago, you made the announcement you're appointing a new senior executive to work on -- I think it is a big data initiative.

I was wondering if you could talk about the size and timing of that opportunity.

Yes, sure.

It was -- we introduced a new set of services under global exchange, and you're probably right to generally related it to big data.

I think within our business -- within our businesses, we have a number of different products and services which are analytical in nature, data-driven analytics for risk management, for performance management, compliance.

And we have decided to pull those together into a separate unit so that we could focus more directly on what we think is a pretty big opportunity, which is more in the middle-office space.

I say middle-office and front-office space on the back of our middle-office position, and more and more of our clients, as we listen to them, are challenged by the need to rationalize their data, to make it more available on a real-time basis.

And in many cases, we are the ones that have that data.

So we formalized a structure that we think will launch us into that space and we're pretty excited about it, but it is going to take some time to sort out exactly how we position the strategy, but we have given it some heft with the existing structure so that we will have some ability to invest in this new area.

And it is -- it does have a big data orientation to it.

Thank you very much.

Jim Mitchell, Buckingham Research.

I just had a quick follow-up on the expense side.

Your compensation expense -- I know, Ed, you talked a lot about the other line.

Your compensation expense was down 2.7% or 2.8% year over year.

Given your outlook on the revenue front, assuming that stays the same, I know it can be tough with incentive comp bounces around, but do you think that kind of year-over-year decline is sustainable for the rest of the year or it is too early to be able to give any kind of guidance there?

I think it is really too early.

Obviously, we are pleased with the 2.7%.

It's, again, reflective of the achievement on the ops and IT program, as well as the effect of the reduction that we announced in the fourth quarter, but I think it is too early to give you an answer to that question right now.

Okay, and then, just one last on the deposits.

Have you seen further deposit outflows in the second quarter?

Or given your discussion around average earning assets, are you seeing it stabilize here and that is part of the issue?

We are seeing it fairly stable.

Okay.

All right, great.

That is helpful.

Thanks.

This concludes today's question-and-answer session.

At this time, I would like to turn the call back to Mr. Jay Hooley for closing remarks.

Yes, thank you.

Thanks, all, for being with us here this morning.

And we look forward to talking to you at the end of the second quarter.

Thank you.

This concludes today's conference.

You may now disconnect.