道富銀行 (STT) 2013 Q3 法說會逐字稿

Good morning and welcome to State Street Corporation's third-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 express 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, Christie.

Good morning, everyone, and welcome to our third-quarter 2013 earnings conference call.

Our third-quarter earnings materials include a slide presentation.

Please note that the presentation includes non-GAAP financial information, reconciliations of our non-GAAP or operating-basis measures to GAAP basis measures referenced on this webcast and other related materials can be found in the Investor Relations section of our website.

Mike Bell, our Chief Financial Officer, will revert to the presentation when he provides an overview of our financial results for the third quarter.

Before Jay and Mike begin their discussion of our financial performance, 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 sections on Risk Factors, concerning any forward-looking statements we make today.

Any such forward-looking statements speak only as of today, October 22, 2013.

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

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

Thanks, Valerie.

Good morning, everyone.

This morning we reported third-quarter operating-basis earnings per share of $1.19.

These results reflect the strength of our core asset servicing and asset management business as well as the impact of seasonal declines in market-driven revenue, including the effect of low interest rates.

Total operating-basis revenue grew about 3% as compared to a year ago quarter and total operating-basis fee revenue increased by 9% over the same period, partly offset by the continuing challenging interest rate environment in investor caution and global markets.

I am pleased with our performance year-to-date highlighted by a 19% increase in operating-basis earnings per share as compared to the first nine months of 2012.

We continue to focus on growing our core business and asset servicing and asset management while carefully managing expenses across the Company.

On an operating basis, we achieved positive operating leverage for this nine-month comparison of more than 200 basis points and have positioned State Street well for continued success.

Our Business Operations and IT Transformation program remains on track to deliver an additional $220 million of pretax expense savings this year and approximately $600 million for the entire program by 2015, while delivering a technology platform that enables product innovation and growth.

Turning to new business, our third-quarter 2013 new asset servicing wins totaled $200 billion which compares to $201 billion and $211 billion of new wins reported last year in the third quarter of 2012, respectively.

Additionally, I am pleased to report that just after the quarter closed, we received a significant commitment from a new client to service assets totaling $137 billion.

On a year-to-date basis, new business is $624 billion as compared to $573 billion in the same period in 2012.

Of the $200 billion in third-quarter new asset servicing wins, 42% were from outside the US.

Also included in our new business wins are 47 new alternative asset servicing mandates, a client segment where we are a market leader and continue to see a above average long-term growth potential.

I would now like to share my insights on market performance and the effect on asset flows we saw during the quarter.

Equity markets were up during the quarter and we did see some close-out of fixed income into equity funds, but we also experienced significant flows into money market funds, reflective of a cautious investment environment.

This environment has also led to lower trading volumes from our clients.

Leading up to the debt ceiling deadline, we experienced a surge in excess deposits and a marked slowdown in trading activity.

Since the temporary debt ceiling resolution of last week, excess deposits have receded and trading activity has improved.

Turning to asset management.

In the third quarter we had net outflows of $15 billion, principally from institutional passive equity funds as well as securities finance cash pools, partially offset by inflows into money market funds and ETFs.

With respect to ETFs, the industry experienced significant volatility during the third quarter.

However, we ended the quarter with $5 billion in ETF net inflows, principally into US equity products.

Fixed income investors moved into our shorter duration products, likely anticipating tapering by the Federal Reserve.

During the quarter we saw $5 billion of inflows into money market funds which, coupled with low market rates, led to an increase in money market fee waivers.

And finally, our new business pipeline in both asset servicing and asset management continues strong and well-diversified.

Now I would like to turn the call over to Mike who will review our financial performance.

Thank you, Jay, and good morning, everyone.

Before I begin my review of our results, I would like to reiterate how pleased I am to be a member of the State Street team.

I am also looking forward to meeting with many of you in the upcoming months.

This morning I will start my review on slide 4 where we have noted several financial highlights for the quarter and for the nine-month period ended September 30, which I will also refer to as year-to-date.

Unless noted separately, I will reference only the non-GAAP operating-basis results in my comments today.

Year-to-date results were strong, despite a difficult operating environment including low short-term interest rates.

Our results were driven by strong revenue growth in our core asset servicing and asset management businesses and continued focus on controlling expenses which has driven an expansion in our operating margins.

Fee revenue growth and expense control remain key priorities going forward.

Our year-to-date operating-basis earnings-per-share has increased 19% to $3.38 compared to the same period in 2012.

Year-to-date our pretax operating margin was 30.2%, which is approximately 160 basis points higher than the same period in 2012.

Our year-to-date return on equity was 10.4%.

Our year-to-date total fee revenue of $5.8 billion increased 8% compared to the same 2012 period.

Primarily due to equity market appreciation, net new business, the revenue contributed by the GSAS acquisition and increased volumes related to foreign exchange trading.

We are pleased with our year-to-date growth.

Third-quarter 2013 earnings per share of $1.19 decreased 4% sequentially and increased 20% from the third quarter of 2012.

Total fee revenue for the third quarter increased 9% versus the third quarter of last year.

Third-quarter 2013 fee revenue was sequentially lower, primarily due to the seasonal decline in securities finance and a summer slowdown in trading services.

We continue to benefit from good execution in managing expenses which remains a top priority.

We achieved 229 basis points of positive operating leverage on a year-to-date basis compared to the same nine-month's period a year ago.

Success in our Business Operations and IT Transformation program has contributed to this result and we remain on track to deliver the expected $220 million of additional pretax expense savings for the full year.

On slide five, you can see that our third-quarter 2013 net interest revenue decreased on a sequential basis as assets that matured or pay down were replaced with lower yielding investments in the current low interest rate environment.

Our third-quarter net interest margin declined to 1.27%.

Our capital position remains strong and return of capital through common share stock repurchases and dividends remains a top priority.

During the third quarter of 2013, we repurchased approximately 8.2 million shares of our common stock for a total cost of approximately $560 million, resulting in average fully diluted common shares outstanding of approximately $452 million for this quarter.

We have approximately $1 billion remaining under our March 2013 common stock repurchase program, authorizing the purchase of up to $2.1 billion of common stock through March 31 of 2014.

We also declared a quarterly common stock dividend of $0.26 a share.

In addition, we declared a noncumulative quarterly perpetual preferred stock dividend of $0.33 a share, which amounted to approximately $7 million.

Now I will discuss additional details regarding our operating-basis quarterly revenue as outlined on slide 12.

Unless otherwise noted, my comments here will focus on the comparison of the third quarter of 2013 to third quarter of 2012.

I believe this is more relevant since the sequential quarter comparison includes the effects of the seasonal pattern in securities finance and the summer slowdown for trading services.

Servicing fees increased 10% primarily due to stronger global equity markets, the GSAS acquisition and net new business.

Management fees increased 10%, primarily due to stronger global equity markets and net new business.

Third-quarter management fees were negatively impacted by $12 million in money market fee waivers and this compares to $5 million in the third quarter of 2012, primarily due to the very low interest rate environment.

Total trading services revenue increased 10%, primarily due to an increase in foreign exchange volumes and volatility.

Securities finance revenues decreased approximately 19%, primarily due to lower spreads.

Securities on loan averaged $316 billion for the third quarter of 2013, a decline from $321 billion in the third quarter of last year.

Processing fees and other revenue increased approximately 23%, primarily due to an increase in fee revenue associated with our investment in bank-owned life insurance.

Net interest revenue and net interest margin continued to be pressured from a persistently low interest rate environment.

On a sequential quarter basis, NIR was lower due to both lower yields in the portfolio and the lower level of average earning assets.

This was partially offset by lower premium amortization on the US mortgage portfolio and by lower rates on our liabilities.

Now as we have discussed previously, we do not expect the recent rise in the 10-year US Treasury bond yield to have a noticeable impact on NIR this year, because we were primarily investing in shorter duration maturities and short-term rates remain very low.

We would need to see a larger increase at the shorter end of the curve to achieve a significant NIR benefit.

Our third-quarter 2013 operating-basis net interest margin or NIM was 127 basis points, down from 131 basis points in second quarter of 2013 and down from 144 basis points in the third quarter of 2012.

We continue to expect operating-basis NIM for full-year 2013 to be slightly below 130 basis points.

This assumes that interest rates globally and client deposits remain at or around current levels for the remainder of the year, which would drive the growth in earnings assets to approximately 5% on the full-year 2013 average versus the full-year 2012 average.

That means that operating-basis net interest revenues expected to be approximately $170 million to $180 million lower in 2013, relative to 2012, taking into account the assumptions that I just noted.

Now let's turn to expenses on slide 13.

Our expenses were well-controlled in the third quarter.

Our compensation and employee benefit expenses decreased approximately 1.5% from both the second quarter of 2013 and the third quarter of 2012.

This quarter's results benefited by approximately $12 million from some adjustments to employee benefits, which we do not expect to repeat next quarter.

Additionally, we had an increase in expenses related to support for new business installations.

Our Business Operations and IT Transformation program continues to be on track.

For full-year 2013, we expect to achieve approximately $220 million in additional pretax expense savings, resulting in approximately $418 million of pretax expense savings since the inception of the program.

Our nonrecurring expenses related to our Business Operations and IT Transformation program were approximately $25 million for the third quarter of 2013.

Now, other expenses decreased sequentially to $251 million primarily due to a third-quarter 2013 gain of $19 million from the sale of a legacy Lehman Brothers-related asset, lower litigation costs including the Lehman recovery, and lower professional services fees and sales promotion costs.

Also impacting the third quarter of 2013 Other expense line was an increase of $7 million for the new Federal Reserve supervisory assessment, which represents approximately two years of fees.

Now, as a reminder, the Other expense line is comprised of many items including professional services fees, securities processing costs, regulatory expenses, and legal costs and can vary quarter to quarter.

Now let me provide you some details on the investment portfolio.

As you can see on slide 14, our overall approach to managing the investment portfolio has not changed.

We have maintained its basic size, high credit quality and composition during the quarter.

The mark-to-market improved at quarter end compared to the second quarter end, mainly due to slightly tighter spreads.

Our interest rate risk position was similar to the second quarter with a sensitivity and economic value of equity or EVE in the up 200 basis point shock scenario at minus 14.5% of total regulatory capital.

The duration of the portfolio was 1.9 years, consistent with the prior quarter.

Additionally, assuming a hypothetical 100 basis point increase in the interest rates across the curve, the unrealized impact on capital is approximately minus $1.3 billion after-tax.

Now we are monitoring and managing our interest-rate risk position using a variety of risk measures including EVE and the potential impact of a rise in rates on the mark-to-market and on NIR.

These metrics are well within our risk appetite.

Maintaining a strong capital position is very important to us.

Particularly in this evolving regulatory environment, we continue to identify opportunities to optimize the capital efficiency of our balance sheet.

Utilizing similar credit experience that we have from investing in corporate bonds and collateralized loan obligations, we have begun to invest in senior secured bank loans, targeting BB and B rated issuers, all subject to our credit underwriting standards.

These loans provide attractive risk adjusted returns and additional diversification to our balance sheet and are not mark-to-market.

Our current exposure is under $1 billion and, while we expect to grow it over time, we plan for it to remain a relatively small portion of our overall balance sheet.

We will continue to look for other ways to optimize the balance sheet that are well aligned with our core competencies and within our risk appetite.

Now let's turn to the next slide to review our capital position.

As you can see from slide 15, we remain focused on maintaining our strong capital position.

This capital strength allows us to deliver on a key priority of returning value to shareholders through dividends and share repurchase.

Importantly, the regulatory capital rules in the US continue to evolve.

As we discussed last quarter, the Federal Reserve released the Basel III final rules in July.

Under the final rule the lower of State Street's tier 1 common ratio, calculated under the Basel III advanced approach and under the Basel III standardized approach, will be State Street effective tier 1 common ratio in the assessment of its capital adequacy for regulatory purposes.

As of September 30, 2013, our estimated pro forma Basel III tier 1 common ratios was 10.2% under the standardized approach and 11.3% under the advanced approach.

In addition, both the Basel committee and the US regulators published proposals for the new Basel III supplementary leverage ratio.

The US proposal includes a minimum supplementary leverage ratio of 5% at the holding company and 6% at the bank level.

We estimate that our pro forma supplementary leverage ratios are approximately 5.4% at the holding company and approximately 5% at the bank as of September 30, 2013.

Now these proposals are still subject to change.

If enacted as proposed, these ratios would take effect January 1, 2018.

Assuming the rules go into effect as proposed, we believe that we have a number of levers which would enable us to comply with these requirements in advance of the 2018 effective date.

Both changes in the rules and the market could impact our anticipated supplementary leverage ratio.

For example, if we are permitted to exclude central bank deposits from the calculation, or if our deposit levels were to return to historical norms, based upon our current balance sheet we estimate our pro forma September 30 supplementary leverage ratio would increase by a little more than 0.5%.

In the meantime, we recently received clarification from the Federal Reserve regarding the incorporation of Basel III into the upcoming 2014 CCAR process.

Our capital planning process already incorporates Basel III compliance standards, so this guidance is consistent with our expectations.

Importantly, in addition to the final rule on Basel III and the proposed supplementary leverage ratio, a number of regulatory initiatives that may impact our capital position and structure and the funding of our balance sheet are still open.

For example, we expect that proposed rules may be released in the coming months regarding minimum long-term debt requirements for the holding company, and the capital buffer for global, systemically important banks.

Of course we continue to carefully monitor these and other potential regulations in development and their aggregate impact upon our business.

We remain focused on executing our capital plan that we submitted in conjunction with the 2013 CCAR, which includes our authorization to purchase up to $2.1 billion of our common stock through March 31 of 2014 of which approximately $1 billion remains available.

Now to recap our results.

Our strong year-to-date fee revenue growth of 8% and our positive operating leverage are indicative of good progress on our top priorities.

We expect our net interest revenue to continue to be under pressure until short-term interest rates begin to rise.

We remain focused on executing our capital plan through March 31 of 2014.

Now before I conclude, I would like to briefly address a question which may be of interest to many investors and analysts regarding our expected capital return in 2014, in light of the evolving regulatory environment.

At this point it would be premature to try to estimate our return of capital beyond our current plan through March 31, 2014.

While we remain focused on optimizing our capital position and returning capital to our shareholders, we do not know how capital regulations will evolve, nor do we yet know all of the parameters for the next CCAR process.

However, we continue to believe that our share repurchase program combined with dividends is the best way to return value to shareholders, and this remains a top priority for us.

And now I will turn the call back to Jay.

Thanks, Mike.

Let me close our call by briefly reiterating our continued focus on creating value for our clients and shareholders by growing revenue and diligently controlling expenses.

Returning capital to our shareholders through share repurchase and dividend remains a top priority.

Now Mike and I are available to take your questions.

(Operator Instructions).

Glenn Schorr, ISI.

Good morning.

One clarification question.

You had mentioned that you were -- I think last quarter you were kind of conservative in the reinvestment.

Duration stayed at [1.9] years and you had maturities run off and replace with lower margin assets.

I think that is all consistent with what you have been saying, but I think the net interest income came a little lighter.

So I guess I am curious.

I heard you loud and clear on some of the things you are doing on the asset side.

But with no change to the rate environment, should we expect a little more of the same, meaning conservative reinvestment and a little more rundown?

Sure, Glenn.

It's Mike.

A couple of comments.

First, I would remind you that the second half of 2013, our outlook is still in line with the estimates that Ed had provided at Q2.

Now, in terms of the moving parts, a couple of comments.

First, around Q3, the NIR was impacted by a couple of different things relative to the NIR in Q2.

First of all, the earning assets for the quarter were down $5 billion relative to the same average in Q2.

So that impacted the NIR.

In addition, as you correctly noted, the average yields did decline for the average yield for the full quarter because of the turnover in the book.

And again, we had anticipated that, given the low interest rate environment, as a general rule replacing the higher yielding stuff that is running off with lower yielding new purchases.

And then just for completeness, I would also remind you that Q2 had a one-time benefit of $7 million in NIR from a paydown of one particular loan.

So, relative to the Q2 comparison there were a few different moving parts there.

On your question on the outlook, it does depend upon a number of factors.

But our current estimate, at this point, would be that we would see a small uptick in Q4 And that would be driven by a couple of things.

First, we do anticipate a small uptick in average earnings assets in Q4.

And we expect an additional benefit in Q4, relative to the slowdown in prepayments on the US mortgage portfolio.

So those are the couple of things for 2014 that -- I'm sorry, for fourth quarter of 2013 that I would expect helping us.

Okay, appreciate that.

And the second question is on the expense side, I think there's a lot of good trends.

Obviously, you point to the operating leverage and controlling what you can control.

It is just interesting how comp -- and I hear you on the one-time benefit, but comp directionally very well contained and the inflows systems and communications line is still up 11% year on year even included in the program.

So I guess it is an A, B question of, A, are the comp trends as a general comment, can we connect --?

We expect that continue.

And B, is this type of growth rate on the Infosystems line what we could expect as you continue to invest in the platform.

Well, first of all I appreciate your comments on expenses.

As we have talked about, controlling operating expenses is a significant priority for us as is generating a positive overall operating leverage.

So that has not changed.

On your specific question of Infosystems and Communications, those have been relatively consistent here this quarter versus last quarter.

And I would anticipate a relatively consistent, maybe up a little bit in Q4.

Again that is all part of the long-term IT and Ops.

So where we have gotten additional savings on the operations side, sometimes that has entailed incremental IT expenses.

But I -- again, I wouldn't read anything into the year-over-year Infosystems.

Because it is all part of the combined IT and Ops program.

Okay.

Those were my two.

Thank you very much.

Howard Chen, Credit Suisse.

Good morning, everyone.

Mike, just a follow-up on the expenses.

You are content to drive a lot of positive operating leverage through the bank.

Putting aside market factors, are there any specific reasons you will give some of that 230 basis points back to finish the year?

And just looking a bit further out than that, can you and Jay just broadly talk about your confidence to drive more operating leverage?

Just given the fact that you have done a lot already, markets are up a lot and the rate environment is not improving.

Thanks.

Sure, Howard.

First, on the remainder of the year, operating expenses, there are several moving parts here.

First, on the comp and benefits.

I don't expect for example that $12 million favorable expense adjustments that we had to -- to employee benefits to repeat in Q4.

So, I would suggest you be cognizant of that plus 12 pressure.

I wouldn't try at this point to put a number on Q4 for comp and employee benefits, because there still are a lot of decisions that we need to make including, for example, incentive comp for the full year.

That true-up, whatever it is, will show up in Q4 and at this point it is too early to try to put a number on it.

The other comment I would make is around the other expenses.

Again, the other expenses do bounce around a fair amount quarter to quarter.

It has got things in there like litigation expenses.

Well, those are basically impossible to predict with any confidence.

So again, difficult to try to estimate the other expenses for Q4.

Ed had commented last quarter that he would expect a normal run rate for the second half of the year to be in the $270 to $280 million range for other expenses.

That is still reasonable, but it doesn't count on anything in terms of unusual items flowing through there.

So other than those two macro points, I wouldn't expect the other line items for Q4 to look a lot different than Q3.

And in terms of how that translates to positive operating leverage, obviously, that will depend in large part on the market-driven revenues and there's several points, both plus and minus, of uncertainty there.

So that would be difficult to anticipate.

Let me ask Jay if he wants to add in terms of the longer term.

Yes, Howard, the only thing I would add is that I think consciously we have been doing a good job of creating operating leverage in this I would say less than normal market-driven operating environment.

And that is largely IT and Ops and trying to become more efficient in all parts of the business.

I would expect over time, as Mike points out, in a more normalized market-driven revenue environment, that we should continue to have good operating leverage.

The higher the revenue growth, the higher the operating leverage is a general theme.

But that's the general strategy.

Okay, great.

And, Jay, my second question, you have spoken a good bit about the alternatives servicing opportunity.

I was hoping you could take a step back, help us place that 47 new mandates in context and talk a bit more about what you are seeing out there today as the fundraising environment for these folks seems like it is improving.

How the competitive landscape and profitability of that client segment is progressing.

Thanks.

Sure.

Happy to do that, Howard.

The -- just to remind everybody, we got into the alternative business early and have not only gone global with it, but have diversified across not only hedge, but private equity and real estate.

So we are pretty confident across the landscape of the alternatives, assets.

I would say general theme, we talk to our institutional asset owners, pension funds and the like.

There continues to be greater allocations to alternatives.

You can look at some of the alternative returns and question that judgment, but that is the trend.

And so we see more assets flowing to alternatives, point 1. Point 2, you see more demands on the alternative asset classes for higher level of compliance and risk reporting, both regulatory and nonregulatory.

So the level of outsourcing continues to move in our favor.

We had referenced before that we think 70% of the hedge marketplace is outsourced to third-party providers, but only 30% in the case of real estate and private equity.

And so we are seeing kind of across-the-board gains across the three asset classes, across the three geographies.

And we don't see that letting up.

The last point I would make is I make the point that we get into this early because if you look at the [league] table of who we are competing with, there's some unusual names.

It is not the typical trust bank names.

So we think we are pretty well-positioned competitively and continue to invest in the platform to differentiate our service offering.

Great.

Thanks for taking the questions.

Robert Lee, KBW.

Good morning, everyone.

My first question maybe, Jay, is for you, but like to maybe get a little bit better sense within asset servicing.

You called that the alternative business, but maybe a little bit better sense of what other segments may be seeing some relative strength or weakness in them.

If I look at your disclosure around AUA and AUC and knowing that that is not -- it is far from a perfect metric, but you do see things like insurance and other growing pretty slowly, whereas comingle -- collective trusts products growing pretty rapidly.

So could you maybe give us a little bit more insight and color in terms of the moving pieces underneath there and where the successes are or aren't?

Sure.

I would say you have got to look at it geographically and by product segment.

Geographically even though 42% of the new commitments this quarter came from outside of the US, [tilted to] was Asia, by the way.

North America continues to be a big driver in spite of maybe expectations a few years ago.

Within the different subcategories, we have a preferred position from a marketeer's standpoint in the asset manager segment.

We like it, we think it offers the most diversity as far as growth and product expansion.

And we continue to do well there.

We've had several competitive wins.

We like the segment.

The segment continues to grow.

Pension a little bit flatter.

Alternatives up and to the right.

I see that continuing.

So, that is kind of the way I see it.

I mean, the Sovereign Wealth Fund marketplace, we -- I was in Asia last week.

We are very well-positioned with the Sovereign Wealth Funds, whether it is oil driven or other commodity driven growth.

Those funds are growing.

They are getting more sophisticated.

They are investing more in alternatives.

Their needs in the middle and back office are increasing.

So I would add that as an additional segment.

Great.

I'm sorry, great, maybe ask my follow-up, curious -- a couple of years ago yourselves and your peers, everyone, that's clearly had similar kind of pressures on top line.

And it seemed like everyone had been focused on pricing and maybe a little more rationality was creeping into the market.

I am curious what you are seeing now.

Maybe you have got some work, competitors in Europe who are feeling their oats a little bit more, at least that they want more fee business or just given that everyone is still under the gun, as it relates to revenue pressure, are you seeing any kind of more, I guess I will call it irrationality creep into the market at all?

Or is it still being reasonably sane?

I would say, Rob, a couple of things that matters a lot by segment.

So in an alternative segment, better than a US pension segment as a for instance, and who the competitors are.

But directionally, I would say, same if not a little better.

I think what you'd hear from me and other trust banks, at least the domestic, the US trust banks, is people trying to get a little bit more rational around fees and trying to work the fee arrangements with their customers to a better place, given the market-driven revenue pressure.

There is some movement, I think, we are all seeing on that and I think that has brought in some maybe more responsible pricing.

In Europe, which would be the other place where custodians live, there is an occasional crazy bid.

But I would say, directionally, nothing really feels very different.

Great.

That was helpful.

Thanks for taking my questions.

Alex Blostein, Goldman Sachs.

Good morning, everyone.

Picking up on the last question, when you look at the growth in your average assets under custody year over year, this year versus last year, you are up about 12%.

When you view the same on the total servicing fees, you are up about 10%.

So it feels like there's still a little bit of a lag between fees and asset growth.

Is there, I guess, A, why do you guys think that is and B, should we expect that gap to close in some sort of a different market environment or should we think of the fees growing at a slower pace on the assets?

Yes, assets, that is a tough relationship and there's a lot of things that go into the fee side of that.

But, if I just pick on the third quarter, just by way of example, I think the third quarter equity markets performed pretty well.

Our service fees were up a little bit.

What sits in the middle of that is a mixed question.

So there was on balance client derisking, which brings less attractive -- or makes it less attractive from a service fee standpoint.

And the other thing was that transaction volumes were down.

So that is another factor that drives the service fee to overall asset growth relationship.

So I would say -- I would just point to that as an example of how these things can shift quarter to quarter, year to date, year to date, I would say overall, in whatever a normalized market looks like these days.

But markets where there's investor confidence, where there is investment across the full spectrum of asset classes including emerging markets, global.

We would expect to see a pretty good relationship, pretty consistent relationship between assets and services fees.

Got you.

And, then, on your -- going back to the balance sheet for a second, your point you are making on derisking during the summer, I guess I was surprised to see the deposits come down as much as they did sequentially.

So maybe a little bit of color on that and how we should think about the overall balance sheet size heading into 2014.

Thanks.

The size of the balance sheet, of course, as well as the level of customer deposits, those vary based on a number of different factors.

We have typically had seasonality in the past where Q3 has tended to be a little bit lower than Q2 and Q4.

We do anticipate the average earning assets for Q4 to be somewhat higher than Q3 which, as I mentioned earlier, is one of the reasons we anticipate a small uptick in NIR for Q4.

But again, this is -- it is an unpredictable period of time.

Obviously, some of the noise in Washington around the debt ceiling crisis led to a temporary increase in our customer deposits.

Most of that has abated, but some has not.

So, again, it's really at this point difficult to predict with certainty where the average earning assets will end up for the quarter.

Got it.

Thank you.

Mike Mayo, CLSA.

First, a general question.

As a new CFO, how are you looking to manage things differently than in the past?

What are your few areas of greatest focus?

Sure.

I think it is a little bit early for me to try to put a stake in the ground on that particular question.

I mean, I really have spent my first 100 days in the job just working to learn the business.

Learn about our issues as a company.

Learn about our internal structure.

So, at this point I wouldn't try to put a stake in the ground saying this is how my regime, hopefully multi-year regime, will differ from the past.

But we could certainly have ongoing dialogue in 2014 on that.

But I think a little early at this point.

And three very small follow-ups.

Why did you guys report so late this quarter?

You aren't usually last, the week after everybody else.

Yes, it is a quick one, Mike.

We had our Board meeting off-site in Hong Kong last week.

We usually annually have a strategy session.

We decided to do it in Hong Kong.

Calendars could only be coordinated the last week, so that is really the reason we put it off a week.

Simply.

Then, a detail question.

If you look at the bottom of slide 13, the bottom right-hand corner, the bullet where it talks about unusual items that helped the third quarter, the gain of $19 million from the sale of the legacy Lehman Brothers-related asset.

And then the Lehman Brothers-related recovery of $11 million.

That is a pretty big one-time benefit for the quarter.

So if you take that out, then it would have been an earnings miss for the third quarter.

I know this is in the eyes of the beholder, but are there any unusual items that would have offset some of those one-time benefits a little bit?

And I guess I asked you, Mike, welcome to the job as CFO, here is an earnings miss, or maybe that is the wrong conclusion.

Well, first of all, as you said, the underlying run rate as you try to scrub one-time items is really in the eye of the beholder.

So it is really a term of art, not science.

I would make the same comment that what you just said on some of the global market-driven revenue.

Because FX volumes were down, and as part of the seasonal slowdown, I would also think of that as not necessarily the long-term run rate as well.

But I would, since you cited the slide 13, I would also reference the $7 million assessment that we got from the Fed for the supervisory fee and that wasn't there at Q2.

So there were several different moving parts.

I wouldn't try to put my finger on an underlying number at this stage, but just to say that we think the underlying fundamental trends for 2013 continue to be good.

We are pleased with the progress we are making on our highest priorities and to me, those are the most important headlines for the quarter.

I have another question, but I will requeue.

Thanks.

Luke Montgomery, Sanford Bernstein.

I wanted to take another stab on the operating margin.

I think you were targeting 400 basis points of expansion with the efficiency initiative.

I think that was off that 2010 base of 28% or 29% and that assumed all else equal.

I was wondering if you might discuss what hasn't been equal, so to speak, in terms of expenses and how that affects your outlook on the level of the margin.

It seems like you are saying now that we need a change in the operating environment, revenue environment, really to exceed a 30.5% margin, but I thought perhaps the projection of 400 basis points really didn't depend on that.

First, just to recap what Ed said again last quarter and what he has said pretty consistently in the past, the starting point for 2010 is 27.5%.

There were some nonrecurring items that he had spiked out in there.

So you really want to think about it as 27.5 plus 400 basis points, to get to an overall pretax margin of 31.5%.

Now on a year-to-date basis we are at 30.2%.

At this point we expect to achieve in 2014 and beyond, another $180 million of Ops and IT Transformation savings.

Bottom line is we still think we can get from the 30.2% to 31.5%.

Now, again, an important caveat as Ed said many, many times is that that does assume all things equal.

And as you indicate, all things are never exactly equal.

And how our mix of business changes, things like the regulatory environment where will interest rates be, I mean, there are a number of other moving parts that can impact our longer term margins.

But at this point we feel good about the savings we have gotten from IT and Ops Transformation and feel good about our trajectory on the year-to-date profit margins.

Thanks.

That was helpful context and helpful reminder.

Then a longer-term question on the balance sheet side.

Could you remind us of what your estimate of excess deposits is currently?

And what impact if any do you expect on your deposit balances, if the Fed were to unwind its balance sheet and take excess reserves out of the system?

In other words, how strong is the linkage between the amount of reserves in simply the banking system and the liquidity that has been aggregating specifically on your balance sheet?

So, in terms of the excess deposits, at Q3 on average, we estimate that our excess deposits were $19 billion for the quarter.

As the Fed unwinds quantitative easing, assuming that the interest rates would rise, I would expect that we would see those $19 billion of excess deposits move off of our balance sheet.

Now again, the pace of that, the timing of that, what other alternatives are out there for our clients to look at, their level of risk appetite in that scenario, those are all moving parts.

Those are all factors that will impact the timing and the amount.

But basically, we think of it as $19 billion of average excess deposits in Q3.

The only other thing I would add is that they have been running higher thus far in October, but, again, we would think that that is probably a temporary phenomenon because of the debt ceiling crisis.

But that is also something that we are watching.

Great.

Thanks for taking my questions.

Betsy Graseck, Morgan Stanley.

Good morning.

Couple of questions.

One is on NIM and you highlighted there is an outlook for a little bit of an improvement as you go into 4Q overall.

Could you speak to the discount accretion because it looks like there was a falloff maybe about half Q on Q?

And I am wondering if -- how you are thinking about that rate of change going forward.

Aren't you specifically referring, Betsy, to the discount accretion from the conduit program?

Correct.

Yes, we did have a rather large paydown in Q2.

I don't specifically have that number off the top of my head.

Again, I think if you adjust for that we wouldn't anticipate a major change, but, again, I must admit I have not squirreled the legacy conduit program in detail to be able to answer your question with a lot of specificity.

Okay, but would you expect that that would just grind down from here, not increase, right?

Yes, that's correct.

Then, maybe we could just touch base a little bit on the securities finance.

I know industrywide there has been -- [SEC] lending has been down on Q and year on year, but maybe you could just highlight if there is anything specifically that was going on in your program to drive the year-on-year decline that we saw?

No, I don't think so.

Our on loan balances are pretty consistent.

They were off a little bit year over year, but a little bit north of $300 billion.

Customers that are in the program are staying in the program.

Demand was off in the third quarter and spreads were compressed and I think it is that simple.

We would expect in a little bit in a better environment demand would improve and hopefully spreads -- spreads are compressed quite a bit from where they were a year ago.

But nothing other than that.

So that is more volume driven than obviously value driven in terms of the market, right?

Because the market was up nicely.

Correct.

And, then the equity market environment that we have got I would have expected that AUC might have been up a little bit more.

And I know you spoke through earlier on the call where you are strong and one of the places you are strong is in the mutual fund industry.

So maybe you could square that a little bit for us.

Yes.

I would say we track almost to the -- as far as our flow intraquarter to the ICI, but we are a little bit different in that we had more of a -- more flows into money market funds, for instance.

Equities, auto bonds, into equity funds, but proportionately more into money funds which is a little bit off of where the ICI data would lead you.

And so the mix was on balance slightly negative from a standpoint of risk-taking and related fees.

(multiple speakers)

This is an unusual quarter based on how market participants were behaving relative to the volatility in the rates market and the government shipment.

I would say equally important was the volume of trading that is also a revenue component of the service fees.

So I would weight that equally with the mix shift.

And I would think the third quarter was an unusual environment particularly the tail end of the third quarter in we saw not only capital markets volumes down, but I think consistent with assets ramping up on our balance sheet, trading was down into the third quarter.

I would hope that is unusual.

Okay, thanks.

Jim Mitchell, Buckingham Research.

Good morning.

Two questions.

One, Jay, you mentioned you've had some pressure on the fee rate from the risking particularly in emerging markets.

But over the last six weeks we have seen a pretty big jump in the emerging markets.

Do you think that could begin to start helping you in the fourth quarter on the fee rate side?

Yes, if it sustains itself, Jim, it certainly would.

We have -- I would say last six weeks you are right and even in the last couple of days post debt ceiling debacle, it looks like risking has improved.

But that's two days don't make a trend, but if that were to sustain itself through the quarter, that would be a good positive factor for us.

Okay.

And on the capital ratios, when we look at the difference between standardized and advanced, should we -- will that difference persists, or should we expect to see that gap close, for instance, as you run off the held to maturity conduit assets?

Is that the major difference or no?

No, Jim.

That is not really the major difference.

The major difference is that the standardized approach has standard risk factors and haircuts which are more punitive really in two areas.

First is they are particularly punitive for the high-quality assets on our balance sheet which is, obviously, the bulk of the portfolio.

And then there are certain off-balance sheet items.

For example, securities finance that the standardized approach is more punitive as well.

So those are really the primary differences.

I would not anticipate that the runoff of the legacy conduit program to be a material driver of that delta.

All right, it won't close the gap, but you will get some RWA benefit for both.

We will get some RWA benefit for both.

Okay.

Thank you.

Andrew Marquardt, Evercore.

Staying on the capital question, can you remind us what is the constraining factor for you guys?

Is it the general [combo] standardized or advanced in the CCAR process, or is it now the SLR?

How do you think about it, or is it just something else?

Well, first, as it relates to this upcoming CCAR, Andrew, I think it is premature to give you a definitive answer, because in fact we haven't seen the instructions yet.

So we will obviously know a lot more when we see the final instructions and the final parameters.

But the way I am thinking about it is really at two different levels.

The first is the quantitative level.

And, yes, we do expect that the Basel III standardized tier 1 common ratios would be an important ratio here for beginning 1/1/2015.

We had anticipated that being the case and, again, believe quantitatively that will be important here beginning 1/1/2015.

I think though, equally importantly, would be the qualitative considerations.

I mean, really, what CCAR is about qualitatively is demonstrating that we do have a robust, long-term, capital plan to be in compliance with the new rules.

So I think both will be important here in terms of the capital distribution plan.

You asked about the supplementary leverage ratio.

I think at this point, that that would be premature in all likelihood.

Although, again, subject to the caveat that we haven't seen the final instructions yet for CCAR.

I would just ask you to remember that the SLR at this point is proposed.

It is not final.

And in prior years we have not been held to proposed rules that are not yet finalized.

So we will learn more over the next coming months and give you an update, but we are really focused on the Basel III ratios and again that, qualitatively, having a long-term robust plan.

And just to add to that for a minute.

We -- I think just yesterday put in our commentary on the supplemental leverage ratio as did other big banks.

The issue that is front and center for us is this whole excess deposit issue.

We hold excess deposit for customers.

We lay them off to central banks.

For us to have to hold 6% capital against that doesn't seem to make a lot of sense given that, I think, the intent of the supplemental leverage ratio is that it is a backstop or a secondary ratio.

So we are hoping that reason will prevail as they finalize that rule.

Thank you, that's helpful.

Then, maybe related, is it also premature to assume that you should keep to what you have been doing the last couple of years of 100% combined payout going into 2014 given these factors and other kind of -- the tough top line, but yet still expense leverage, et cetera?

The short answer is yes it is premature to comment on that.

Then, if I might, one second topic on expenses.

Can you remind us in terms of where you stand on the IT expense initiative?

I know you are about 70% through that, I guess.

Did you say that you were going to basically be at the full run rate by the end of 2014?

Did I hear that right?

And then, also, you have that additional expense initiative of [$90 million] savings that you previously talked about being at 70% heading into this quarter.

I'm sorry, at the end of last quarter.

Where do we stand on that as well?

Thanks.

Okay, sure.

We would anticipate achieving our aggregate IT and Ops savings of $600 million in the first half of 2015.

So what that means is we have got approximately $180 million left as of year-end 2013.

We have got $130 million that we expect to impact 2014 and then another $50 million that we would expect to impact 2015.

And, again, we are on track for the 2013 target.

So I would not expect, for example, incrementally more expense saves in Q4 versus Q3 on the 2013 tranche.

Those expenses at this point have been basically captured.

On your question on the year-end 2012 program, at this point we have captured those savings in the run rate.

And, so again, at this point those have been executed on.

So with that is it fair to assume that you can achieve positive operating leverage on a year-over-year basis again, even in this tough top environment if it lasts for longer into 2014?

Is that a fair assumption?

Yes, again, it is a little early to comment on 2014 definitively.

Again, I think the main question is really the market-driven revenues, what is that environment going to look like.

If we saw a more return to normal, for example, with interest rates as well as some of the market-driven revenues, we would anticipate a positive operating leverage.

But, again, certainly at this point that is a goal, but I wouldn't say that we could give you guidance at this point on 2014.

Thank you.

Cynthia Mayer, Bank of America Merrill Lynch .

To clarify on the improvement you expect for 4Q in NIR.

Is there any reason that wouldn't continue into 1Q of next year and beyond?

Is there anything particularly seasonal about the increase in earnings assets you are expecting in the improvement?

Yes, Cynthia.

Again, it is really early to try to give you thoughts on 2014.

It will just depend upon a lot of different factors.

Notably, I would point out would be the view on market interest rates.

I mean if market interest rates continue to be static, then we would anticipate additional downward pressure on NIR and NIM next year.

But again, early to try to put any numbers around it.

On the deposit question, we do anticipate continuing growth in the book of business, but, again, at this point I wouldn't try to give you a definitive outlook for 2014.

Okay and to follow up on the AUC and I realize a few people have asked about this.

So, at the risk of beating a dead horse, it seems like your AUC was up about 1% sequentially despite pretty strong markets in an asset mix which is pretty well weighted towards equity.

So aside from things like fee rate questions of fee rate and that sort of thing, just based on the mix of assets you began with, why wouldn't it have been up more just based on the market appreciation in the equity assets?

And should we conclude that you had some net outflows that offset the $200 million or so --?

Or the 200 of wins you mentioned or was there something lumpy beyond that?

Let me try that.

We didn't have any big outflows or losses that contributed to that.

It is really more a matter of our mix, which was more negative from a standpoint of client risking, meaning more into money market funds versus equities which is a slight difference from where the market was combined with, in our service fee business, transaction fees are an important component of fee rate and transactions were off quite a bit in the third quarter.

So, really, those are the factors.

I guess I was asking more about the ending asset level than the fees.

The ending asset levels --.

Up only 1%.

Let me take a look at that, Cynthia.

From $18.8 trillion to $19.2 trillion.

Is that the reference?

Oh, okay.

Maybe we should just pursue this off-line.

Okay, great.

Fine.

Thanks.

Ken Usdin, Jefferies.

Good morning, everyone.

Jay, I was wondering if you could elaborate a little bit more on the pipeline, the pace of potential wins across both servicing and asset management.

I heard your comment about the big win coming in just after the end of the quarter, wondering if that is any indication that you are starting to see some potential chunkier pieces of business up for bid and potentially landable?

Yes, I would say pretty steady.

I mean that new business win that we committed after the quarter was chunky.

But I would say pretty steady.

I am particular a pleased with our competitive win rate when we are -- it is not only the alternative, but asset management business.

Our win rate is quite high.

We have had -- and the pipeline is pretty solid and pretty diversified.

So I wouldn't directionally say better or worse, but pretty steady.

What about underneath that granularity of, like, is the type of business you are bringing on higher or lower incremental margin relative to history or recent periods?

Are you seeing better business?

If the volume is static, what is the context of the type of new business you are bringing on?

Yes, I would say in a world of $200 billion a quarter which is a lot of deals underlying that, it is a real mix.

I would give you a few examples.

We seem to have an additional alternatives, the ETF servicing business is a real strong category for us.

In the Goldman acquisition, the GSAS acquisition, we said we thought we could cross-sell.

We have done a terrific job at not only cross-selling, but taking relationships that were thinly serviced and moving up into the back middle office.

Two big deals there which are very attractive from a standpoint of return.

So, it is without going through a list, Ken, it is hard to directionally say better or worse other than very diversified and a good solid pipeline.

And, Mike, you announced that 200 billion of new, but can you give us the left to convert on both the asset servicing and the asset management side?

I will give you that, Ken.

On the asset servicing side between everything we have committed up till now, plus the 200, there's about 185 that is in the pipeline waiting to convert.

Is that what you are looking for?

Yes and that is as of the third, right?

That is excluding the new win?

That include -- that is excluding the new win, correct.

So the 127 plus 184 would be the to be installed number.

And how about on the management side?

I don't know that I could give you that number.

Okay.

Last really quick one, one final one on the expenses.

So, you are at the run rate for this year's plan.

This year the bulk of the saves came in earlier in the year.

Is it the same context we should expect from the incremental benefits for 2014?

Does most of it come in the early part of the year like it did this year?

I would say generally the answer is yes.

I wouldn't say necessarily use the exact same percentages that we delivered on this year.

We are still working through the specifics of the 2014 budget.

But generally it is right that we tend to focus on getting those saves in the first half of the year.

But not necessarily all of them.

Great.

Thanks.

Gerard Cassidy, RBC.

Good morning.

Can you go over the loan portfolio, how you grew it, Mike, in the quarter?

Can you tell us -- you said it was going to grow to a larger size.

I may have missed the percentage of loans, but how big do you think that could get to on the B -- BB/B credits that you mentioned earlier?

At this point we haven't specifically sized our capacity there.

It will be something that we will continue to look at throughout 2014.

I would say to put an upper ceiling on it, I would not anticipate it, for example, reaching 3% of our total balance sheet, but other than giving you that as an outer ceiling, I wouldn't try to put a size on it for 2014 yet.

It is still something that we are looking at.

And did that portfolio contribute to the drop in the average rates that you reported on your average balance sheet which came in at 1.66% for loans and leases down from 2.29%?

No.

That, again, it was a relatively small number in terms of volume, Gerard, and that particular loan book is mainly -- it actually has mainly nothing to do with leverage loans.

Leverage loans are only $0.5 billion of that number.

The particular number that you are focused on is mainly the loans that we do for example to -- for closed end mutual funds.

And so, again, apples and oranges there.

Sure.

What contributed then to the decline in the yield in the portfolio?

Or was the yield unusually high in the second quarter?

Again, it is basically just a change in mix.

We have been growing that particular loan book.

We have liked the characteristics of that book.

We think they are attractive risk-adjusted spreads, but the nominal yield in any particular quarter is going to bounce around based on the mix of those funds.

And finally, on your interest-bearing deposits section of the liabilities, we noticed all year a steady decline in the US accounts.

Can you share with us what's driven that number down to about $5.8 billion from about $16 billion at the beginning of the year?

Right.

Mainly that is the maturing of the wholesale CDs that we had really back in 2012.

That's been -- those have been generally maturing off of the balance sheet.

Thank you.

Mike Mayo, CLSA.

Question for you, Jay, when you benchmark your pre-tax margin, you are squarely in the 30s, whereas your peers are in the mid- to upper 20s.

And I am trying -- do you claim victory there?

Are their business mix differences and is there a lot more to go once you finished this process with the IT and Ops Transformation?

But before you answer that, maybe for you, Mike, just to get clarification.

How much in the IT and Ops savings did you have in the third quarter for the total program and how does that compare to the second quarter?

In terms of the IT and Ops program, we are now at the full year run rate saves here at Q3.

So, again, we will get another tranche in Q4, but incrementally Q3 to Q4 is approximately zero.

So we are already at the full year rate.

I just don't quite remember Ed's number from Q2.

So there was a small benefit Q3 to Q2.

It was not particularly material in the grand scheme of things and as I mentioned in the prepared remarks, Mike, we are essentially offset by some of the incremental operating expenses from new business installations.

So, again, when you wash out those two together it is approximately flat.

(multiple speakers).

Yes, so we have $180 million left at year end in the entire program.

$180 million for 2014 and 2015.

So, 180 million total.

If you add that to 30.2% year-to-date rate then you are already -- if you get that, that is, 32% pre-tax margin, you will be there?

Yes, but, importantly that is all things equal.

There are any number of different things in terms of mix of business, regulatory cost, where will NIM be.

Again, there -- your arithmetic is correct, but I wouldn't conclude then you should plug 32% into your model.

Okay.

And, Mike, let me pick up the other question with regard to declaring victory.

To meet the IT and Ops Transformation, everybody wants to focus on the expense saves, which are important, but equally important to me is transforming our IT operation to improve our operating environment, to reduce costs, to improve client service delivery.

So I think it is transformational not only because of the efficiency, but because of where it puts us relative to (technical difficulty) new products and evolving the cloud.

So, it just seems like a natural for this kind of business to move in that direction.

All right, thank you.

Thank you.

Christie, before we end, let me just -- I don't know if Ken Usdin is still on the line, but I just wanted to reference that to his question of the SSgA uninstalled new business was around $25 billion, just for the record.

And with that, I would just conclude we look forward to speaking to everybody at the conclusion of the fourth quarter.

Thank you.

That does conclude today's conference call.

Thank you for your participation.

You may now disconnect.