道富銀行 (STT) 2013 Q4 法說會逐字稿

Good morning and welcome to the State Street Corporation fourth-quarter 2013 earnings conference call and webcast.

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

(Operator Instructions).

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

Thank you, Stephanie, and good morning, everyone.

Welcome to our fourth-quarter 2013 earnings conference call.

Our fourth-quarter earnings materials include a slide presentation.

Unless otherwise noted all the financial information discussed on today's webcast will reflect operating basis results.

Please note that the operating basis results are a non-GAAP presentation and this webcast includes other non-GAAP financial information, reconciliations of our non-GAAP measures including operating basis results 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 refer to the presentation when he provides an overview of our financial results for fourth-quarter and full-year.

Before Jay and Mike begin the 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 included, those indicated by the 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, January 24, 2014.

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 to all.

We are pleased to report our fourth-quarter and full-year 2013 results which reflect our focus on our key priorities to deliver value for clients and shareholders.

Mike and I will comment on our full-year 2013 results but will focus our remarks on the fourth quarter.

Then we will share some initial observations about our expectations for 2014.

By many measures 2013 was a strong year for State Street.

For the full year, we reported operating basis earnings per share of $4.54 which is a 14.9% increase over full-year 2012.

We stayed focused on our key priorities growing our core business, controlling our expenses and returning capital to our shareholders.

While we benefited from the strong equity market performance, we executed on our strategic priorities against the headwinds of low interest rates and increasing regulatory requirements.

For full-year 2013, we -- total operating basis revenue 3.3% to more than $10 billion despite the pressures from the low interest rate environment.

We grew core servicing and management fees approximately 10% over 2012.

We ended 2013 with a record $27.4 trillion in assets under administration and a record $2.35 trillion in assets under management.

We delivered approximately $220 million of incremental pretax expense savings in conjunction with our business operations and IT transformation program during 2013 and we achieved positive operating leverage of 171 basis points for full-year 2013 compared to full-year 2012 calculated on an operating basis.

Additionally, we returned approximately $2.5 billion in capital in 2013 to our shareholders through common stock repurchases and dividends.

Turning to the fourth-quarter 2013 results, we reported operating basis earnings per share of $1.15.

Reflected in these results was the continued strength of our core asset servicing asset management business partially offset by lower foreign exchange trading revenue.

Now I would like to share some insight on our new business and our client asset flows during the quarter.

Regarding new business, our fourth-quarter 2013 new asset servicing wins totaled approximately $392 billion.

Of these wins 30% were from outside the US.

Also included in these new wins were 41 million alternative asset servicing mandates, a client segment where we remain the market leader and continue to see above average long-term growth potential.

Regarding flows, equity markets rose significantly during the fourth quarter stemming from continued optimism regarding an economic recovery especially in light of the Fed's decision to pay for its bond purchases and maintain a low rate environment.

Our clients experienced increased flows into equities and continued outflows from fixed income funds.

Similar to last quarter, we also continued to see client flows into money market funds.

Additionally we continued to experience high levels of client deposits in the fourth quarter.

Trading activities during the quarter were weak as the threat of the global ceiling showdown closed markets in the first part of the quarter and volatility was low throughout the quarter.

Turning to asset management in the fourth quarter, we experience net inflows of $5 billion driven primarily by strong inflows into ETFs, partially offset by institutional outflows from passive equities driven by client rebalancing and re-risking.

We also experienced short-term outflows in securities finance pools offset by inflows into money market funds.

With respect to ETFs, we experienced strong inflows of $18 billion led by our S&P 500 fund and our Sector Spider funds partially offset by continued outflows from our Gold ETF.

Our new business pipelines in both asset servicing and asset management remain strong and well diversified.

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

Mike?

Thank you, Jay.

Good morning everyone.

This morning before I start my review of our operating basis results, I would like to mention a couple of nonoperating items included in our GAAP reporting.

First, our GAAP results for the quarter included a $71 million tax benefit associated with the completion of a multiyear project related to our deferred tax accounts.

This contributed approximately $0.16 per share to our GAAP earnings in the fourth quarter.

In addition, the quarter included $45 million of additional accruals for costs associated with previously disclosed litigation and non-US regulatory matters.

This reduced GAAP earnings by approximately $0.06 per share in the quarter.

Now I'll review our offering basis financial highlights beginning on slide 10.

From this point on, I will reference only our non-GAAP operating basis results in my comments.

Overall our strong full-year 2013 results were driven by year-over-year fee revenue growth of 7.4% and good execution on our priority to effectively manage our expenses.

In full-year 2013, we achieved approximately 15% year-over-year EPS growth despite low short-term interest rates which negatively impacted both our net interest revenue and our securities finance revenue.

We also generated 171 basis points of positive operating leverage comparing full-year 2013 to full-year 2012 and improved our pretax operating margin to 30.1% for full-year 2013.

Our return on common equity increased to 10.3% for the full year.

Now turning to slide 11, fourth-quarter 2013 earnings per share of $1.15 decreased from third-quarter 2013 primarily as a result of the soft trading environment.

The fourth-quarter operating results also included several noteworthy items.

Net interest revenue included $19 million of revenue associated with a municipal security that was previously impaired.

Other expenses included $28 million of securities processing costs offset by Lehman Brothers related gains and recoveries.

Compared to the fourth-quarter of 2012, EPS increase primarily due to higher fee revenue and a reduction in the number of our outstanding shares partly offset by increased expenses.

Fourth-quarter total revenue increased compared to the third quarter of 2013 driven by higher core servicing and management fees and higher net interest revenue partially offset by lower trading revenue.

Total expenses increased in the fourth quarter compared to the third quarter primarily due to higher compensation and benefits, occupancy and other expenses.

During the fourth quarter, we repurchased approximately 8 million shares of our common stock at a total cost of approximately $560 million resulting in average fully diluted common shares outstanding of approximately 445 million for the quarter.

At year-end, we had approximately $420 million remaining on our common stock repurchase program which is effective through March 2014.

We declared a quarterly common stock dividend of $0.26 per share and also declared a noncumulative quarterly perpetual preferred stock dividend of $0.33 per share during the quarter.

Turning to slide 12, I will discuss additional details of our operating basis revenue for the fourth quarter of 2013 focusing on the notable variances.

Fourth-quarter servicing fees increased approximately 2% from the third quarter and 7% from the fourth quarter of 2012 primary due to stronger global equity markets and net new business.

Fourth-quarter management fees increased approximately 5% from the third quarter and 12% from the fourth quarter of 2012, respectively.

The increase in both periods primarily reflects stronger global equity markets.

Fourth-quarter management fees were negatively impacted by $13 million of money market fee waivers compared to $12 million in the third quarter of 2013 and $5 million in the fourth quarter of 2012.

For the full-year 2013, money market fee waivers were $40 million.

Performance fees in the fourth quarter of 2013 were approximately $5 million, up from $4 million in the third quarter and down from $8 million in the fourth quarter 2012.

Total trading services revenue decreased 11% compared to the third quarter primarily due to lower foreign exchange trading revenue from lower market volatility.

Compared to the fourth quarter of 2012, total trading services revenue decreased 6% primarily due to lower fees associated with the Spider Gold ETF.

Securities finance revenue increased approximately 3% from both the third quarter of 2013 and the fourth quarter of 2012.

Average securities on loan were relatively unchanged sequentially at $315 billion.

Processing fees and other revenue increased approximately 3% from the third quarter of 2013 primarily due to an increase in revenue associated with tax advantaged investments.

The decrease from the prior year quarter is primarily due to specifically noted gains recorded in the fourth quarter of 2012.

Operating basis net interest revenue of $596 million in the fourth quarter of 2013 increased from $553 million in the third-quarter 2013 due in part to $19 million in revenue associated with a previously impaired municipal security.

In addition, higher interest-earning assets and lower mortgage prepayments contributed to the sequential increase in net interest revenue.

Excluding the $19 million in net interest revenue associated with the municipal security, our operating basis net interest margin in the fourth quarter of 2013 was 125 basis points.

Now let's turn to operating basis expenses on slide 13.

Our total expenses for the fourth quarter of 2013 increased from the third quarter primarily due to higher compensation and benefits, occupancy and other expenses.

Our fourth-quarter 2013 compensation and employee benefits expenses increased 3.4% from the third quarter primarily due to lower benefit costs resulting from planned changes in the third quarter as well as increased costs in the fourth quarter to support new business.

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

For full-year 2013, we achieved approximately $220 million in additional pretax expense savings resulting in approximately $420 million of incremental pretax expense savings since the inception of the program.

Our nonrecurring expenses related to our business operations and IT transformation program were approximately $26 million for the fourth quarter of 2013.

Occupancy expenses of $124 million in the fourth quarter increased relative to the third quarter of 2013 primarily due to the effect of a one-time $8 million charge in this quarter associated with a sublease renegotiation.

Other expenses increased to $292 million in the fourth quarter of 2013 largely due to higher securities processing costs, professional services fees, and sales promotion costs.

The fourth-quarter also included $28 million of Lehman Brothers related gains and recoveries compared to $30 million in the third-quarter 2013.

Compared to the fourth-quarter of 2012, other expenses increased primarily due to higher securities processing costs.

Now I will provide you with some details on our balance sheet.

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

We maintain a high credit quality profile with 89% AAA- or AA-rated securities and 44% of our securities fixed-rate and 56% floating-rate.

Our interest rate risk position was in line with our position at the end of the third quarter of 2013 and the duration of the portfolio remains relatively unchanged at approximately 1.9 years.

Additionally, the unrealized mark to market loss increased during the quarter to $213 million primarily due to a rise in market interest rates.

We monitor and manage our interest-rate risk position using a variety of risk measures including EVE, primarily to determine eventual impact of a rise in rates on both the mark to market and on our net interest revenue.

During the fourth quarter these risk metrics remained within our risk appetite.

Maintaining a strong capital position is very important to us particularly in this evolving and complex regulatory environment, we continue to identify opportunities to optimize the capital efficiency of our balance sheet.

As we reported last quarter, we begun to invest in senior secured bank loans targeting BB-rated and B-rated issuers, all subject to our credit underwriting standards.

As of year-end 2013, this loan book exposure was $931 million.

In accordance with GAAP, we recorded a provision for loan losses of approximately $6 million in the fourth quarter related to the aggregate senior secured bank loan portfolio.

This calculation is based upon market credit loss factors for loans with similar characteristics and does not reflect an identified loss event for any particular loan in our portfolio.

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

As you can see we maintained a strong capital position and that strength has allowed us to deliver on our key priority of returning value to shareholders through dividends and common stock repurchases.

As of year-end 2013, our estimated pro forma Basel III Tier 1 common ratio was 10.1% under the standardized approach and 11.8% under the advanced approach.

We estimate that our pro forma Basel III supplementary leverage ratios under the US proposed rules are approximately 5.2% at the holding company and approximately 5.0% at the bank as of December 31, 2013.

The slight decrease in the holding company ratio from the prior quarter is primarily due to the influx of client cash deposits on our balance sheet at year-end 2013.

Recently the Basel committee released its final rules on the supplementary leverage ratio.

While there were several modifications made to the rule that if adopted by the US regulator would be helpful to us, we are disappointed that the committee did not exclude central bank deposits from the denominator and we will continue to work with the US regulators to seek exclusion when the US rules are finalized.

The target effective date is January 1, 2018.

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

The Basel committee also updated their thinking on the net stable funding ratio.

While there is still more work to be done, the recognition of some liquidity value and operational deposits is helpful to us.

Again, we believe that by the targeted effective date of January 1, 2018, we will have taken appropriate actions to be in compliance with the rules.

In October, the US banking regulators issued a notice of proposed rulemaking or proposed rule intended to implement the Basel committee's liquidity coverage ratio or LCR.

While the US proposed rule is generally consistent with the Basel committee's LCR, it includes certain more stringent requirements including an accelerated implementation timeline and modifications to the definition of high-quality liquid assets and expected outflow assumptions.

The proposed rule remains subject to interpretation, regulatory guidance and public comment until January 31, 2014 before the issuance of a final rule.

In addition in December, five federal agencies issued final rules developed jointly to implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the Volcker Rule.

We continue to analyze the proposed rules and their potential impact on us and intend to develop and implement any changes to ensure compliance.

In the meantime, we remain focused on executing 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, 2014 of which approximately $420 million remained available as of year-end 2013.

So to summarize our results, our strong performance for the full-year 2013 was driven by positive core servicing and management fee revenue as well as our continued control over expenses.

We are proud of achieving 171 basis points of positive operating leverage for full-year 2013 compared to full-year 2012 and increasing our pretax operating margin to 30.1%.

Now let's turn to our 2014 outlook on slide 17 beginning with revenue.

For 2014, we expect total revenue growth to be in the range of 3% to 5% compared to 2013.

This growth rate is predicated on a number of important assumptions.

First, we plan to continue to execute on our top priorities driving core revenue growth, investing in new growth opportunities, controlling expenses, and managing our strong capital position.

Second, we assume a modest increase in market interest rates later in 2014.

As we have discussed previously until short-term interest rates begin to rise, we expect our net interest revenue to continue to be under pressure.

For planning purposes we assume equity markets defined as the S&P 500 and EVE, will remain close to year-end 2013 levels for the full-year 2014.

In addition, we expect that the market environment will improve and benefit both our securities finance and trading revenues.

We continue to target positive operating leverage on a full-year basis.

Our ability to achieve this goal is highly dependent upon our continued diligence in controlling expenses across the Company.

We continue to expect to achieve an incremental $130 million in pretax expense savings in 2014 from our Business Operations and IT Transformation program and to continue to invest in initiatives to drive revenue growth from the expansion of new products and services for clients in key sectors and geographies.

Additionally, we expect some upward pressure on regulatory compliance costs.

I would also like to remind you that as in prior years, the first-quarter 2014 compensation and employee benefits expense will be higher due to the effect of the accounting treatment of equity compensation for retirement eligible employees as well as for payroll taxes.

We expect the incremental amount attributed to equity compensation for retirement eligible employees and payroll taxes in the first quarter of 2014 to be approximately $150 million.

In 2014, we expect to remain focused on optimizing our strong capital position and returning capital to our shareholders.

We plan to complete our current 2013 common stock repurchase plan effective through March 31, 2014.

In addition, we submitted our 2014 CCAR plan to the Federal Reserve which included a capital distribution program of dividends and common stock purchases that we believe is consistent with our strong capital position and earnings capacity.

The amount and form of capital distribution in our plan is contingent upon the Federal Reserve not objecting to our request and we expect to receive the results of their review in mid-March.

We continue to believe that our common stock repurchase program combined with dividends is the best way to return value to shareholders and return of capital remains a top priority for us.

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, diligently controlling expenses, and returning capital to our shareholders through common stock purchases and dividends.

Stephanie, Mike and I are now available to take questions.

(Operator Instructions).

Glenn Schorr, ISI.

Thanks.

Mike, just a point of clarification in the outlook on the modest increase in market interest rates, are we talking specifically short rates later in 2014?

Then just curious, does that even impact NII in 2014 or is there a lag and it really starts impacting in 2015?

The short answer is we do expect by the end of 2014 an increase in market interest rates both at the short term as well as at the intermediate term and we would expect some modest benefit from that in net interest revenue and importantly as well in the securities finance revenue that it would help immensely to see some uptick for example in the 90-day rates for the securities lending business.

What we intend to do, Glenn, is at the Investor Day, where we have time to provide some greater context to give you some of these scenarios that we have looked at.

So I think we can answer that question pretty thoroughly for you here on February 27.

Okay.

On a related note, ECB had cut -- I went back and looked -- the last comment I saw was 25 basis points equaled something like $40 million in annual revenues.

I am just curious if that relationship holds and how you are thinking about ECB as they talk about the potential for going negative on deposit rates.

Do you have to park the money in the same locale?

Can you park your money elsewhere?

Ballpark, Glenn, we still think that sensitivity of the $40 million is rational.

Again let us give you a more thorough answer to some alternatives when we see you in February.

Okay.

Last one just as a reminder for myself, you have a pretty big gap between our spread between your standardized and advanced Basel III ratios.

So I am curious A, what produces the bulk of that large gap; and B, does it impact how you go about the CCAR process?

Sure.

So, Glenn, first you are absolutely right at the moment we have 170 basis point spread between the advanced approach and the standardized approach for the Basel III risk-weighted asset calculations.

As we talked about last quarter, there are two main drivers of that.

First, the standardized approach uses standardized risk factors and haircuts where the advanced model uses advanced model driven loss estimates and the standardized risk factors and haircuts are more punitive in two areas.

First, certain off-balance-sheet items for example around the securities finance business is treated more punitively under the standardized approach and the other area that is more punitively treated is the high quality assets and our balance sheet is chock full of high quality assets.

So as a result under the current environment with our current balance sheet, the standardized approach is the more punitive one of the two.

Do you anticipate a changing behavior?

Because it would seem counter State Street counterintuitive to change your quality metrics based on that.

Or just it is what it is and hopefully the metrics will adapt to the quality of the balance sheet?

In other words, all I'm looking to find out is does it change how you go about your capital return thought process?

Sure.

So, Glenn, we do need to meet the more onerous of the two requirements under the CCAR stressed scenario so as we are working to sort out how to optimize our balance sheet mix going forward, that is part of our calculations, that is part of our thinking around balance sheet strategy for the future.

I would remind you that the standardized ratio does not kick in until 1-1-2015 so for 2014, the binding constraint is the advanced approach.

But again, CCAR is about the long-term as much as it is about the short-term so qualitatively as we go through CCAR we need to be cognizant of the supplementary leverage ratio that may be coming down the line as well as the more onerous of the standardized and advanced approach and that is why the work that we are doing to optimize our balance sheet under the new rules is something that is a pretty complex undertaking.

But we are confident we are going to be in compliance and as we draw conclusions on that we will certainly plan to communicate that.

Okay.

Thanks, Mike.

Ken Usdin, Jefferies.

Good morning.

Mike, I just wanted to ask you about the outlook for revenues.

You are very clear on positive operating leverage.

You've got the pretax margin at 30% this year and last year you did 170 basis points of operating leverage.

I was just wondering if you can help us put in context what type of magnitude of improvement can we see on both the pretax margin direction and if you can maintain or even increase that operating leverage gap?

Sure, Ken.

First, I would prefer to wait until the investor day where we have time to give you some additional context.

For example, we do plan -- as I mentioned to Glenn, we do plan to share some of the modeling we have done on various interest rate scenarios, as well as talk about work that we are doing in our core businesses to drive revenue growth, but also in some of the new growth opportunities that we see out there.

And then we will also talk about some of the areas where we are investing.

So I think, and I would prefer, rather than trying to give it to you in a 30-second answer on a crowded conference call, I would rather wait and give it to you at the investor day.

But I think, stepping back, to me what is most important is that, even in a relatively low growth environment where we would expect revenue growth to only be 3% to 5% compared to our long-term targets which are quite a bit higher than that, we still believe we will be positioned to achieve positive operating leverage.

Perhaps not as much as 2013, but again another step forward on the operating leverage and, therefore, we would expect again good progress as an enterprise through our strategic goal of being a low-cost provider in this business.

Okay.

Then my second question relates to just I want to understand the increase in the FTE adjustment, which obviously gets backed out from a GAAP perspective.

But can you just walk us through the elevated tax adjustment, tax investments, how much is that carrying now in that processing other and if this is the new run rate for that because I don't think people would have expected that to be as much of a back out this quarter?

First of all as we have previously disclosed, we have been steadily looking for opportunities to make tax advantaged investments and we have been doing that pretty consistently over the last couple of years and that has been a beneficial in terms of our effective tax rate.

On the specific tax equivalent adjustment for Q4, why don't we take that one off-line.

I think we are going to talk to you a little bit later today.

It is just not a simple calculation so I would prefer to do that again not in a crowded conference call if you will.

Okay.

My last question and just to get more granular then on the quarter itself then is -- a lot of people are asking about the elevated other expenses and can you just help us reestablish a base for what that line should look like going forward because I think that is again that is another key question I think in terms of the stock reaction today.

First, on the other expenses, as we have talked about previously, remember this stuff can bounce around quarter to quarter because some of the costs in this category are pretty lumpy.

And a good example of that is the securities processing costs so the securities processing costs in the quarter were $28 million.

We don't think $28 million in a quarter is reflective of our outlook going forward but it is a good reminder that the number does bounce around quarter to quarter.

Now I would point out recently in the recent past we've been doing a good job in this area and we would expect that to normalize in 2014.

But that would be an example why I don't think the $292 million in total for the other category is a good run rate going forward.

Then just to talk about a couple of the other larger pieces, we had sales promotional costs of $6 million this quarter that mainly as part of our year-end process to support our investment management business so that was planned but again, we view that as a Q4 item.

We would expect that to normalize back out in Q1 so again I would reduce for that.

I would say the big wildcard really are the higher legal and regulatory compliance costs and that reflects a combination of this regulatory environment that we are operating in where we have had to spend more money on a variety of things that in an ideal world we wouldn't but we do within this world and we have had to spend some more money in that area in particular more money on professional services which increased for the quarter.

And then the legal costs, which primarily relate to prior-year problems but they are areas where we do need to spend money to support our position.

So at this point the number has been bouncing around enough and there is enough uncertainty around our regulatory compliance costs, Ken, that I would prefer not to give you a new range or something like that for 2014 but I do think at our Investor Day we can give you some additional color on how we are thinking about it.

Okay, thanks, Mike.

Alex Blostein, Goldman Sachs.

Good morning, guys.

I was hoping you could comment on the kind of continued disconnect between your servicing fees and (inaudible) administration and I think this is the phenomenon that we've seen for almost two years now and even this year when your average assets are up 12, fees are up 9; last year they were up 5, fees were flat.

So can you help us flush out I guess this dynamic and what needs to happen to bridge that gap going forward?

Yes, let me start that, Alex, and Mike will pick it up.

First off, I look at market and service fee correlations and if you look at -- it is hard to examine much in a quarter but if you look year-over-year service fees are up 9%.

Equity markets were up big, fixed income markets were not.

So if you piece that apart a little bit, a couple of factors.

One is the mix, the question of when you look at the global services business, I think by our calculation less than half of the revenues are tied directly to assets so the other half are tied to other fee levels, other fees that are unassociated with assets.

I guess the other thing I would say which makes the question even murkier is if you look at the baseline, the baseline of service fees in any given period or a period-over-period change is influenced by investor flows and given that we have proportionately as a trust bank higher exposure to asset managers, flows make a big difference.

And if you look during the course of 2013, we had some positives so obviously equity markets and equity flows were very positive but fixed income flows were pretty negative.

In the second half of the year, they outstripped positive equity flows.

And so you've got that factor.

And then you've also got the factor of the emerging markets pullback in the fourth quarter was also a little headwind.

So I am not sure that explains but at least it gives you some of the ingredients that determine service fees.

Mike, do you want to pick up anything else?

Only a couple of things that I would have.

First I would just reinforce Jay's point that it is important to note that only -- in fact a little less than half of the service fee revenue line is directly driven by the basis points on assets so that really is an important point.

You would expect in a market -- we would expect in a market where the markets are rising that the service fees would trail the increase in assets because of that phenomenon.

And then I would just round it out, transaction fees are between 10% and 15% of that particular number and transactions were up just a blip relative to Q3 but were down relative to Q2.

So again, transactions will tend to move in general with the relative bullishness or really relative to kind risk on, risk off in the market and that has been something that has been a headwind for that line item in the third quarter and fourth quarter.

Lastly, out-of-pocket expense recoveries also impact that line item.

So again just to give a specific example, we had lower out-of-pocket expense recoveries of $6 million that is essentially the same $6 million of the drop in the information systems line item on the expense side.

So again, there are going to be some things that don't matter from a P&L standpoint but can bounce around in the servicing fees line item in particular.

Got you.

You guys didn't mention pricing.

It is fair to assume that you haven't seen any change in the way certain businesses are priced relative to what they have been or what kind of (inaudible) you are winning?

I would say directionally, Alex, no real change in certain markets in certain product lines.

It is highly competitive.

It is less so than others.

We continue to try to send signals to the market by backing away from deals that become so thinly priced in an attempt to try to establish more reasonable pricing but that is a journey more than an event.

No marked change in pricing over the course of the last quarter.

Got you.

Mike, I was hoping maybe you could flush out a little bit more than net interest guidance for next year.

Just a couple of nuances around the balance sheet size.

I'm not sure how much you expect to leave in the first quarter so what do you guys think as far as the average size of a balance sheet goes for 2014?

Sure, Alex.

First of all again, we will give more color, more detail on this at the Investor Day.

But if I focus just on Q1 for a second, we did see an increase in the excess deposits on our balance sheet of approximately $6 billion Q4 relative to Q3.

So the excess deposits we estimate in Q4 was approximately $25 billion.

I would expect that number will decline in Q1 and decline even further by the end of 2014 if in fact short-term rates begin to rise as we anticipate that they will.

So I think it is important to factor that into the thinking.

In terms of the core deposits, we do we expect that over any longer period of time we expect that there will be growth in our core operational deposits essentially commensurate with our overall fee revenue growth and our overall client base.

Again, I would view that as sort of small single digits over the course of the year so therefore I would expect a drop in the excess deposits on average to reduce our average assets for full-year 2014.

Got it.

Thanks very much.

Luke Montgomery, Sanford Bernstein.

Hi guys.

Just a quick question, a follow-up on Glenn's question about the 2014 outlook.

I think it was my understanding I think generally people see or feel that your balance sheet is short-term liability sensitive.

In the past you said that your net interest margin could actually compress until rates stopped going up.

So has there been a change in your thinking about how rates affect your balance sheet and NIR at least in the short term?

Obviously I'm still relatively new here so I can't connect all the dots from prior discussions but here is how we are thinking about it.

We are thinking about it that a rise in short-term interest rates in particular, the 30-day and the 90-day rates in particular would be particularly helpful to us because remember over half of our balance sheet is comprised of floating-rate securities and therefore as short-term rates rise, we get an automatic pickup in NIR from those securities.

On the liability side, we would expect that liability rates would ultimately increase with short-term interest rates but in the near-term, they would likely increase at a slower pace than what we would pick up on the yield side.

So if you take the combination of the benefit I just described on NIR combined with the benefit on the securities lending business, that would be a much better environment for us to operate in if short-term rates in particular would rise.

Now I think that the question you are asking around the long-term interest rates may tie back to our mortgage-backed securities in the portfolio.

We were in a phenomenon where there was some risk of those assets extending and then that having a collateral impact on the need to reduce the duration of our portfolio.

I think if there is good news is that that issue for the most part is behind us.

There is not a lot more extension left in that particular book so I wouldn't expect the second order impact of that phenomenon to hurt us in 2014.

That is helpful.

Back of envelope analysis would suggest that your organic growth in the custody business has been averaging somewhere around 1.5% over the last four years.

I was hoping whether you would affirm or deny if that seems like a reasonable guess-timate?

And then I think given the strength of the new business wins you announce each quarter it does seem to suggest that you are losing some mandates and so perhaps you could put that estimate in the context of how you are feeling about your market share gains or losses?

Then along with that, have you given any more thought to increasing disclosure around components of organic growth?

My sense is that the investment community really would like to see you and your peers move in that direction but I think it is going to take one of you to set the disclosure bar higher for everybody so wondering if that is going to be you?

Let me jump in there.

Let me first lap the question of client wins and losses and market share gains and losses.

I think -- we don't win everything we compete for, there are some things that we really go after and we don't win but I would say our win and loss rate for those things that we think are attractive where we have a differentiated position therefore we can get decent pricing is quite good.

I would point to segments like the alternative segment which I frequently bring up.

I think we have a differentiated value proposition there.

We tend to compete very effectively.

We don't win them all but we do pretty well.

I would say the same thing for -- very involved in integrated complex asset manager sales particularly if there is a middle office to it.

Again the number of competitors shrink and we fare pretty well there.

You could say the same for some markets overseas.

I would say as a general theme, we compete more effectively in the asset manager segment versus the asset owner segment so that is funds versus pensions as the theme which leads you to things like offshore markets, Luxembourg, Dublin, very competitive there.

Market share data is not easy to come by.

There is probably the deepest markets in the world for custodians would be markets like the US Mutual Fund Market.

I think that is probably a market that has the clearest data, the ICI puts out information.

And I would say that if you look at that as we look at that, we are gaining market share in that what we think is a key segment.

With regard to picking another one of your questions, the organic growth as Mike has come on board, we have spent time with several of you in groups and individually and we are really thinking about ways where we can express more clearly the issue of what drives organic growth and then incremental new business and we don't yet have a conclusion on that but I understand the point both the keen interest in understanding the drivers of that and also the point about somebody needs to lead.

Thanks a lot.

I appreciate it.

Josh Levin, Citigroup.

So we have seen some turmoil in the emerging markets in terms of equity markets and also in terms of the FX markets.

How do we think about how that sort of turmoil affects your business both the positives and the negatives?

Let me start that one, Josh.

If you look at the core global services business, the type of asset that we are servicing is affected by -- the revenues are affected by the type of asset we are servicing.

So in a simple example, domestic equity versus an emerging market equity or bond is going to carry a lot more revenue per unit of asset so that is the first thing.

So as there is a retreat from emerging markets which we saw in the fourth quarter as well as we saw a little bit more recently over the last couple of days in the core global services business that is a headwind.

So movement into emerging markets would be a big positive given the incremental fees that we get associated with servicing emerging markets type instruments.

On the foreign exchange side, it cuts back a little bit the other way.

Good market movement in and out of emerging markets and volatility would be a positive thing.

Although even though we have seen retreat from emerging markets, volatility remained pretty low throughout the fourth quarter which you might say is a little unusual.

My second question is about M&A.

So there is a lot of speculation that M&A is going to pick up in the United States this year.

If we do see more deals, a higher number of deals, a greater dollar value of deals, how should we think about that affecting your business?

I think there is a lot of discussion and actually there has been some action broadly in the merge and acquisition activity.

I don't think you've seen much in financial markets and I guess the way we would look at it is break it down a little bit.

In the core asset servicing business, it would have to be very special and I cannot imagine -- one, I can't imagine anything significant because I think it would get considerable regulatory scrutiny.

And if it was a small add-on to us, it would have to be very attractively priced for us to be interested in it.

I have said before that in the core custody business I don't feel like we have any big gaps in our offering.

Geographically we are pretty well placed.

From a standpoint of asset classes with the moves we made into alternatives, pretty well placed.

So I don't feel like there is a gap that we need to fill and so therefore any acquisition would be largely an acquisition of clients and again size, large sized deals would be off the table in my opinion and small sized deals would have to be extraordinarily attractive from a financial standpoint.

I think probably off of your question but a little bit on the small end of acquisitions, small software products or capabilities that would round out some products in our asset management business or in our emerging risk and analytics business that might be interesting but I would say the big stuff for us is very unlikely.

Thank you.

Mike Mayo, CLSA.

I just want to know if we are expecting too much too soon from the business op and IT program if we should collectively stretch out our expectations?

I guess fourth quarter was a pause on the efficiency progress linked quarter -- your 70% done with the business op and IT program for the expense savings.

You said to expect positive operating leverage this year but a little bit less and that is partly predicated on higher short-term rates this year.

But maybe with the expense savings mostly done, should we think about the additional benefit to be less visible in your earnings?

And I will refer to -- there is a new book out this week by your neighbor some MIT professors called The Second Machine Age, and they looked at 600 firms and they showed that it takes five to seven years before you really get the full benefits of productivity.

So while the best expense savings I think are behind you based on your reported numbers, should we be looking out two, three, four years from now?

Let me start that one, Mike, and our Mike can jump in.

We are entering the next to final year of our publicized IT and ops transformation.

We've got $130 million that we've got to achieve this year and then there is a sub for 2015.

You know because I've taken you through this before that what we have done is structurally changed the cost of delivering core services here.

We have centralized and standardized and leveraged offshore locations highly successfully and now we are in that last leg of rebuilding the systems to make those processes even more efficient.

And what you will say this year and next year is the wrap-up of that.

What inspired me along the way was you mentioned the MIT professors, the book that McAfee and his partner wrote on the race against the machine and maybe this is phase two of the book that you are referencing but what you take away from that is that the power of technology in these transaction processing businesses is in the early innings.

So I look at what we have done and we restructured our their operations.

We are applying technology but as we look out into the future, I think it only gets more interesting frankly as we look at now that we have standardize these things how much labor we can take up by displacing it with technology.

And one of the great examples that that book referenced which was insightful to me is the driverless car from Google and what technology can accomplish today and I don't think generally the financial markets -- and you might even say the financial transaction processing businesses in the financial markets -- have anywhere near matured out that opportunity.

So as a follow-up and I don't want to put words in your mouth.

It sounds as though you are as confident as ever about the future but what I think I'm hearing is a little bit less confidence about this year in front of us and if there is one item that changed from a few years ago when you started on this initiative, has it more than any other factor simply been the regulatory cost, has that been the unexpected negative surprise?

I would say that is pretty fair, Mike.

I think unfortunately I would have thought two years ago we would be cresting the hill and we would be declining our investment in these kinds of things but it has not happened that way.

Just a simple example that maybe highlights some of my frustration and some of the cost is you look at the Volcker rule which for a firm like State Street has not a significant impact yet the systems that we are building to report on, the trading that we are doing to prove that it is not proprietary is just mind blowing.

So I think you are right that probably one of the biggest surprises -- I guess the other thing I would say though is we are also trying to walk a fine line between becoming more efficient and continuing to invest and I think that so for the short term, we are trying to deliver good value to the shareholders but we are also continuing to invest and you have heard me say before that this IT and ops transformation probably the most exciting future aspect of it is laying a new technology which will allow us to be more agile with regards to introducing new products both -- particularly in the data space.

But you are right just to go back to your point about regulatory and generally compliance cost has been the biggest surprise.

Thank you.

Marty Mosby, Guggenheim.

Good morning.

I wanted to kind of go back to the rate sensitivity discussion and, Mike, you had mentioned kind of running your simulations that you saw short-term asset yields would go up faster than the short-term liability costs.

When you report your economic value of equity I think the brackets mean that that is negative which means that a rising interest rate environment I think would be negative to equity.

I just want to make sure that I was reading the brackets right.

Yes, Marty, it's Mike.

You are reading the brackets right.

Now importantly, that relates to the mark to market on the balance sheet so again a little bit different phenomenon than what kind of impact would that have on our net interest margin and net interest revenue in 2014.

So I just wanted to make sure there really is a disconnect between what you are looking at there and you are saying the major difference is just the mark to market on the investment portfolio?

Yes and importantly, Marty, the EVE is the entire balance sheet so again it is a little bit apples and oranges but again sort of two different phenomenon going on here.

The rise -- I will repeat -- the rise in the short-term interest rates would be particularly helpful to our net interest margin and net interest revenue for 2014 and we believe that the impact on the mark would be manageable over the period.

And I think also what is probably building into your EVE looking so negative is the duration assumption that you are probably applying to your deposits and [DDAs] and transaction accounts (multiple speakers) a lot longer life.

That is absolutely right and that is one of the issues around EVE which is why we really look at a variety of different risk metrics, not just the EVE to measure our overall profile.

I just wanted to reconcile the comment you made earlier to that number.

That helps a lot.

Thanks.

(inaudible), Credit Suisse

So I just wanted to first dig into the expenses this quarter.

I guess I was surprised if I look at Infosystems and communications, I was surprised by the tick down there.

And then if I look at salaries and benefits and I look over the past three quarters, you have managed to show year-over-year declines and this is the first quarter where it actually went up.

So just wondering if you would provide some additional color there.

Sure, it is Mike.

I will start.

On the information systems line item importantly, that did include a decline of $6 million in out-of-pocket expenses which really means that we spend that money on behalf of our client and then get that money back in service fees.

So there was a $6 million downdraft in both servicing fees and the information systems costs related to that phenomenon.

So I think it is a little bit of a one-off and I wouldn't put a lot of weight into those.

More importantly on your question on the comp and benefits first of all, the Q3 comp and benefits included a one-time benefit of $12 million from a change we made in one of our employee benefit programs.

So we had talked about that on the Q3 call being one time and that you ought to naturally think that that $12 million it will go back up $12 million all things equal in Q4 and that has materialized the way we expected.

The bulk of the remainder though in the comp and benefits is to support our new business.

We are obviously pleased with our overall new business results for full-year 2013 and even accounts that will be generating revenue early in 2014 and we did have an increase in the new business support costs.

This would include things like the onboarding contractors that we use, it would include the growth in the alternative investment business that Jay referenced earlier, it would include year-end sales comp.

So that is related to new business.

And as we look to first quarter of 2014, we do expect that to normalize other than of course the $150 million one-time impact we will have in the first quarter from the annual incentive comp, put that aside, we expect the comp and benefits to normalize again in Q1 as we work through that onboarding.

Thanks for the color there.

Mike, I appreciate that you will be providing more details on your 2014 guidance on your Analyst Day but I just want to clarify the bottom end of your 3% to 5% revenue growth, does that assume a rise in interest rates?

That is a difficult question to answer in a vacuum.

The 3% bottom of the range does look at a more pessimistic market environment than our base case scenario.

So I would say that it wasn't quite as precise as the question you are asking but I think it is fair to say that if we did not see a change in interest rates then we would be more likely to be closer to the 3%.

But again, there are a lot of moving parts there and I think we can give you a more thorough answer when we take the time at the Investor Day to walk through that.

Okay.

I guess finally, alternative sources has been a great business for you guys and you have a strong presence there.

How are you thinking about (inaudible) opportunity from here?

What can you do organically into 2014 in 2015?

Let me take that, Ashley.

We think that we compete effectively and we do well in the hedge fund segment of alternatives.

By our estimate, 70% of the hedge funds have outsourced the kind of work that we do so there is potentially an additional market share gain, there is potentially more hedge funds which we will outsource and I think maybe it is not a certainty but it is highly likely given the pressures that hedge funds are under to be more transparent to their customers.

But I guess the other element of alternatives which is kind of exciting is we have also moved into private equity and real estate subsegments of alternatives and by our estimate and industry estimates, only 30% of those firms have outsourced so we would expect proportionately greater growth in those non-hedge alternative segments and we feel well positioned.

Great.

Thanks for taking my questions.

Betsy Graseck, Morgan Stanley.

Good morning.

I had a follow-up on the other side of the revenue guidance, the 3% to 5% range that you talked about so the 3% is a more negative outlook than your base case for interest rates.

But can you give us some color around what is the assumptions behind the boundaries on the upper end of the 5%?

Again I would prefer to go into that level of detail at the Investor Day but broadly speaking, we would expect at the 5% scenario broadly speaking, we would expect a rise in both short-term as well as intermediate-term interest rates certainly beginning July 1. And in that kind of environment it is likely to be a more positive global economy so in that kind of environment with a more positive global economy and higher 30-day and 90-day interest rates, we would expect the sec lending business to be stronger, we would expect our trading revenue to be stronger and we would expect that to mean good things for topline as well as bottom line.

But let me leave it at that and save the additional detail here for Investor Day.

Okay, great.

Because the implication is that the fee line is a plus 4 grower and that seems a little bit modest compared to what you have done historically.

That would be great to flesh out at Investor Day.

And then just separately on the expense line, you have discussed regulatory a couple of times and I know throughout the conference calls of the prior year you have indicated where regulatory expenses have crept up.

So we've had rising regulatory costs throughout the year.

I guess what I'm wondering is as we look at the year-on-year because you called out the year-on-year would have a higher reg cost -- is it a run rate from 4Q?

In other words, is the higher year-on-year a function of the fact that regulatory costs increased throughout the year or are you also saying that there is increasing reg cost from your 4Q run rate?

Betsy, I would think about it as a full-year to full-year as opposed to a full-year to the fourth quarter.

The fourth quarter in our expectation was relatively high in a number of these legal and regulatory compliance areas.

I would think about it more year-on-year as opposed to year versus Q4.

Excluding legal just the regulatory cost itself, what you are basically saying is your run rate in 4Q is a decent run rate for the full year?

Yes, I don't think I would be quite that precise but I think our comments around the upward pressure on regulatory compliance costs if you exclude legal really related to full-year 2014 versus full-year 2013.

And one of the reasons just in full disclosure here, and it is a difficult question to answer, is that keep in mind we've got spending across the enterprise that is driven by these demands so it is not like it is a discrete budget that captures all of the dollars.

I mean many of us around this table are spending a lot more time on regulatory compliance issues than we have in the past.

So it impacts, it really pervades a number of different budgets, it pervades systems cost relating to the Volcker reporting that Jay referenced earlier and it increases the staff that we need in the compliance area in VRM.

It increases the professional services expenses so it is not sort of a readily easy single number to point to which is why again I would just urge you to focus more on the year-over-year trend.

I get that.

I just wanted to make sure -- your message is essentially look -- those expenses have been rising throughout the year for things we all know about, that is what you're making a statement on not necessarily there is more coming that we are anticipating from 4Q annualized.

So that answers the question.

Thanks a lot.

Robert Lee, KBW.

Good morning, everyone.

Just a couple of quick questions.

The first thing is I'm just kind of curious -- I mean the -- and this also occurred in 2013 but the normal seasonal bump in Q1 comp, it's the year over year was 7% increase was pretty (inaudible) increase this year.

Is that simply just related to higher expected comp accruals as businesses grow?

I mean -- it seems like a pretty outsized kind of jump?

Sure, Rob, it is Mike.

In terms of relative to the Q1 bump that we saw in 2013, there are a couple of different things going on.

First of all, it does reflect the fact that full-year 2013 was a better result for the enterprise than full-year 2012.

So that is reflected in what we expect the management compensation to be here in the first quarter.

So that is a piece of it.

Second, we have had some changes in the demographics so the main impact that we get of course is the impact of those that are age 55 and have had five years of credited service.

Again that demographic has contributed to the increase.

And then importantly, we have approximately $10 million increase year over year related to some new regulations, new compensation regulations in Europe.

So there was some compensation for certain individuals that had to be unadjusted and as a result, that drives that number up $10 million versus first quarter of 2013.

Maybe my next question is going back to trying to think about the asset servicing line and business mix and maybe this is something you intend to address at the Investor Day.

But if I look at the assets under custody administration and I'm actually looking at page 12 on the trends report where you have the breakdown by funds, collective funds, I'm assuming that collective funds is where most of the alternative products sit.

But is that -- should we think of that as a reasonable representation of those segment's contribution to the fee revenue line or is it really not much of a correlation between their relative size and growth and how they are contributing to asset servicing fees?

Just trying to see if there is a way of using that data to kind of triangulate to kind of the growth expectations for servicing?

Unfortunately it is not quite that simple and as Jay indicated earlier, it is something that we are working on.

Now how much of that we will have done by the Investor Day remains to be seen.

But let us work to give you an update hopefully a down payment at the Investor Day and more to come here later in 2014.

Fair enough.

That was my questions.

Thank you.

James Mitchell, Buckingham Research.

Good morning.

Just one or two quick follow-ups.

One on the balance sheet -- just your comment that you saw a spike in excess deposits around $6 billion.

I am assuming you are talking about on an average basis because deposits were up $28 billion on a period-end basis and if you could just sort of -- is the commentary that those -- the vast majority of that $28 billion rolled off?

Is that how we should think about it?

Yes, I was referring to the average, on average our excess deposits in Q4 were approximately $25 billion compared to $19 billion on average for Q3.

Importantly we saw two significant spikes in the fourth quarter.

We saw a significant spike in October around the debt ceiling crisis and then we saw an even larger spike at the end of December that is impacting the period-end number that you are describing.

And so again, it was well north even of the numbers that you were quoting.

So again, we tend to focus on the period averages because that tends to be more of a driver of the net interest revenue and net interest margin.

No absolutely but you are saying that won't have -- the period-end balances won't have any real impact on the average going into the first quarter because they rolled off?

Is that the (multiple speakers)

That is correct, Jim.

They rolled off at the beginning of January, not the whole 25 but the spike that we saw at year-end rolled off and I would expect on average for Q1, it to be below 25 again barring another crisis in Washington here later in the quarter.

Or in emerging markets I guess.

Just a follow-up also on the conversation, you mentioned you had expected to normalize in 1Q.

I wasn't quite sure I understood what you were referring to.

Is that the seasonal uptick in incentives or it wasn't clear to me what you were referring to.

Let me just go back to that point.

First of all, we will have this $150 million increase in Q1 related to the annual compensation cycle so put that piece aside.

If you strip that out of our Q1 2014 numbers, what I was saying was that if you strip that out if you took the Q1 2014 versus the Q4 2013, we would expect the comp and benefits to decline over that period mainly because we don't anticipate those expenses that supported the new business in Q4 to continue through Q1.

Any ballpark on that number?

It was the bulk of the rest of the increase from Q3 to Q4 if you strip out the $12 million of the benefit plan change in Q3.

So round numbers call that $15 million.

I would again anticipate that $15 million not being there in Q1 of 2014.

Okay, great.

That is very helpful.

Thanks.

Cynthia Mayer, Bank of America Merrill Lynch.

Just a follow-up on the asset servicing question.

If 50% is driven by asset levels and 10% to 15% is transaction, is it possible to generalize about the biggest drivers for the remaining 40%?

Is that just number of accounts or the type of service provided which we really can't see?

It tends to be the latter, it tends to be fixed fee arrangements or other particular services.

Again just not specifically tied to either transactions or basis points on asset.

So again an example, I keep harping on it but just to give the example, $6 million of servicing fees from Q3 went away in Q4 and these were out-of-pocket expense recoveries where we do spend money in this case on information systems but charge the client dollar for dollar for that.

So again there is a drop in information systems but a drop in revenue so it is those kinds of things, Cynthia.

Again, we will look to add some transparency on that over time.

Let me give you just one other example Cynthia because it is a meaningful (inaudible).

With each portfolio if we are doing portfolio accounting, there is a fixed fee to provide that fund accounting so obviously that would be driven by the number of portfolios that we add versus assets just as another example.

Okay, got it.

And then on your outlook for 2014, it sounds like you are assuming improvement in market conditions for both sec and trading.

I guess the sec lending sounds like will be helped by better short-term rates but what gives you confidence on the trading and any color you can give on what you are seeing so far this quarter since 4Q was so slow?

You are right.

With regard to securities lending.

I would also add another little element which could be helpful and it came up earlier in the call that the M&A activity has picked up and to the extent that stays robust, that would increase the number of special securities and so that is a helper to securities lending as well.

With regard to foreign exchange, our comments are probably more a reflection of the unusual decline in volatility in the second half of the year that we don't think that is a normal state of markets and I think you can look at the Fed pulling back, you can look at some of the emerging economies and some of their actions as indicators that our base case would be -- we would see a little better volatility in this year, 2014, than we saw in 2013.

By the way, volumes in our foreign exchange business have been pretty good so it is really more of a factor of volatility.

Okay.

Any color on what you are seeing so far this quarter?

Too early to tell.

Okay, thanks a lot.

At this time I will turn it back over to management for closing remarks.

We would just thank you for your attention this morning and look forward to hopefully seeing most of you in a little more than a month in New York on February 27 where we will host our annual analyst call.

Thank you.

Thank you.

This concludes today's conference.

You may now disconnect.