道富銀行 (STT) 2014 Q1 法說會逐字稿

Good morning and welcome to State Street Corporations first-quarter 2014 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 at the State Street website.

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

(Operator Instructions)

In the question and answer session the Company has requested 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 induce Valerie Haertel Senior Vice President of Investor Relations at State Street.

Go ahead.

Thank you Stephanie and good morning everyone and welcome to our first-quarter 2014 earnings conference call.

Our first-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 financial highlights presentation when he provides an overview of our financial results for the first quarter of 2014.

Before Jay and Mike begin their discussion of our financial performance I would like to remind you 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 2013 annual report on Form 10-K and in subsequent filings with the SEC.

We encourage to you review those filings including the sections on Risk Factors concerning any forward-looking statements we make today.

Any such forward-looking statements speak only as of today, April 25, 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 and good morning everyone.

During the first quarter, our results were affected by a constrained investment environment and seasonal expense factors.

However we continue to execute on our key priorities of growing our core business, controlling our expenses, investing in growth areas and optimizing our capital structure to deliver long-term shareholder value.

The environment during the first quarter was mixed.

Global equity and fixed income markets were up slightly and investor risk taking behavior had a negative bias until the end of the quarter when investors began to move back into emerging markets.

While volatility improved from the fourth quarter and helped our trading business it remained constrained hitting a seven-year low during the quarter.

Concerns about the Ukraine and growth in China simmered throughout the quarter.

But there were no significant impacts on the geo political front.

On the State Street front we experienced seasonal expense increases in the first quarter, as well as continued pressure on regulatory expenses.

As a result of this tepid environment we have taken action to further align our expense base by announcing this morning a reduction of 400 positions.

We are committed to aggressively managing our costs and we will continue to evaluate additional opportunities to create efficiencies to position us to achieve our goal of creating positive operating leverage year-over-year.

The constrained environment and increasing regulatory requirements are also putting pressure on our clients.

Consequently we continue to see steady demand for our products and services around the globe.

Our first quarter 2014 new asset servicing wins totaled approximately $189 billion, representing a range of clients and sectors.

38% of those assets were from outside the US.

Included in our new business wins are 25 new alternative servicing mandates, a client segment where we continue to see above average long time growth potential.

New assets to be serviced that remain to be installed in future periods total $136 billion.

During the quarter, we saw outflows from money market funds into long-term funds.

However as the quarter progressed the flows into long-term funds shifted from equities to fixed income and out of emerging markets funds and into mature markets, which is indicative of continued cautious investor behavior.

As mentioned we did see some movement back into emerging market equity funds at the end of the quarter.

In our asset management business we experienced net inflows of $4 billion for the first quarter, driven primarily by strong inflows of $35 billion into cash collateral pools offset by $31 billion in outflows from ETFs and institutional mandates, primarily passive equity.

The net ETF flows of approximately $19 billion reflect a typical seasonal activity in our S&P 500 fund.

In this continued challenging environment our objectives for 2014 are to drive growth from the core business, continue to mine efficiencies across the organization, including executing on option IT transformation program, invest in growth areas and deliver positive operating leverage on an annual basis.

Now I would like to turn the call over to Mike who discuss our actions more fully and review our financial performance.

Thank you Jay and good morning everyone.

This morning before I start my review of our operating basis results I would like to note that our GAAP basis results for the first quarter included a pre-tax severance expense of approximately $72 million related to staff reductions and realignment.

As Jay noted this action was taken to help mitigate environmental pressures and to align our expense base with our current revenue outlook.

We continue to focus on one of our key priorities, which is to support positive operating leverage on an annual basis in 2014.

On page 11 I'll begin a discussion of our operating basis highlights and I'll reference our non-GAAP operating basis results in my comments unless I note otherwise.

EPS for the first quarter 2014 declined $0.99 per share from $1.15 in the fourth quarter of 2013 an increase from $0.96 per share in the first quarter 2013.

Our first quarter results in 2013 and 2014 included the seasonal effect of deferred incentive comp and payroll taxes.

Compared to the first quarter of 2013, the increase in operating basis EPS was primarily driven by a reduction in average outstanding shares, due to our common stock repurchase program.

First quarter 2014 total revenue increased 1.2% compared to the fourth quarter of 2013, and 3.6% compared to the first quarter of 2013.

Total expenses increased in the first quarter of 2014 compared to the prior quarter primarily due to an incremental $157 million related to incentive comp and payroll taxes of which $146 million is associated with the seasonal deferred incentive compensation for retirement eligible employees and payroll taxes.

During the first quarter of 2014, we repurchased approximately 6 million shares of our common stock at a total cost of approximately $420 million, resulting in average fully diluted common shares outstanding of approximately 439 million for the quarter.

In March of 2014, our Board of Directors approved a new common stock repurchase program authorizing the purchase of up to $1.7 billion of our common stock through March 31 of 2015.

Turning now to slide 12, I'll discuss additional details of our operating basis revenue for the first quarter of 2014, focusing on the notable variances principally from the fourth quarter.

First quarter 2014 servicing fees were up modestly, compared to the fourth quarter of 2013, primarily due to stronger global equity markets and net new business partially offset by lower transaction related revenue.

First quarter 2014 management fees increased modestly from the fourth quarter of 2013, primarily due to net new business and stronger global equity markets partially offset by lower performance fees.

Performances fees in the first quarter of 2014 were approximately $3 million, down from $5 million in the prior quarter.

Additionally first quarter 2014 management fees were impacted by money market fee waivers of $10 million compared to $13 million in the prior quarter.

Trading services revenue increased by almost 5% compared to the fourth quarter primarily due to higher foreign exchange trading revenue from higher volumes and volatility.

Compared to the first quarter of 2013 trading services revenue was lower, primarily due to lower foreign exchange trading revenue and lower distribution fees associated with the SPDR Gold ETF.

Securities finance revenue increased for the fourth quarter of 2013, primarily due to higher spreads and volumes.

Securities on loan averaged $333 billion in the first quarter of 2014, up approximately 6% from the fourth quarter of 2013.

Processing fees and other revenue increased approximately 20% from the fourth quarter of 2013, primarily due to an increase in revenue from joint ventures, tax-advantaged investments and certain portfolio transition services.

Our net interest revenue decreased from the fourth quarter of 2013 primarily due to $19 million of interest revenue recorded in the fourth quarter of 2013 associated with a municipal security that had previously been impaired and lower yields on interest earning assets.

I'll also reiterate the two net interest revenue scenarios that we reviewed at our February Investor Day.

In our first scenario we assume a modest improvement in market interest rates, but not administered rates later in 2014 and we would expect full year NIR to be $25 million to $50 million lower than 2013 adjusted NIR of $2.289 billion.

The second scenario assumes a static interest rate environment at 2013 year end levels for the remainder of 2014 and we would then expect our full year NIR to be $50 million to $100 million lower than the 2013 adjusted NIR of $2.289 billion.

Our operating basis net interest margin in the first quarter of 2014 was 124 basis points.

As a result of the persistent low interest rate environment we expect the net interest margin to continue to move lower until market interest rates rise.

Average interest earnings assets increased from the fourth quarter which is primarily driven by higher levels of client deposits.

I'll now update you on how we are positioned related to the liquidity coverage recovery ratio or LCR.

We expect to be above the 80% minimum requirement for the LCR as of January 1, 2015.

This will likely result in a higher level of high-quality liquid assets on the balance sheet which will have a negative impact and this impact is reflected in our full year estimates.

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

Our total expenses for the first quarter of 2014 increased approximately 9% sequentially, primarily due to seasonal deferred compensation expense and payroll taxes, and higher information systems and transaction processing expenses.

Our first quarter 2014 compensation employee benefits expenses increased from the fourth quarter 2013.

Primarily due to an incremental $157 million related to deferred incentive comp and payroll taxes of which $146 million is associated with seasonal deferred incentive comp expense for retirement eligible employees and payroll taxes.

Compensation and employee benefits expenses continues to be impacted by costs associated with installing new business, investing in growth opportunities, and implementing additional regulatory and compliance requirements.

Our business operations and IT transformation program continues to be on track and for full year 2014 we expect to achieve approximately $130 million of additional pre-tax expense savings which would result in approximately $550 million of run rate savings since the inception of the program.

Information systems expense increased from the fourth quarter of 2013 primarily reflecting the planned transition of certain functions to external service providers as well as higher maintenance costs associated with the new technology implemented as part of the business ops and IT transformation program.

Transaction processing expenses increasing from the fourth quarter of 2013.

The increase primarily reflects higher volumes and higher equity values in the investment servicing business.

Occupancy expenses of $114 million in the first quarter of 2014 decreased sequentially.

Primarily due to the effect of a one time, $8 million charge in the fourth quarter of 2013 and a $4 million credit in the first quarter of 2014, each associated with a sub-lease renegotiation.

Other expenses decreased to $283 million in the first quarter of 2014 compared to the fourth quarter of 2013, primarily due to lower securities processing, sales promotion and professional services costs.

I would also note fourth quarter 2013 operating basis other expenses including $28 million of Lehman Brothers related gains and recoveries which was essentially offset by higher securities processing costs.

Now I'll provide you details on our March 31, 2014 balance sheet.

As you can see on slide 14 our overall approach managing our investment portfolio has not changed and we maintained a high credit quality profile.

Our interest rate risk position was also in line with our position at year end.

Additionally the after tax unrealized mark to market gain as of March 31 was $124 million which improved from year end, due primarily to narrower spreads in the first quarter.

Now turn to the next slide to review our capital position.

As you can see we maintain 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 March 31, 2014 our estimated pro forma Basel III tier 1 common ratio was 11.1% under the standardized approach and 13.2% under the advanced approach.

Both capital ratios improved from the fourth quarter primarily due to an increase in tier 1 common equity.

This increase included a temporary 20% phase-in of the deduction of other intangible assets from tier 1 common equity as allowed by the phase-in rules.

Previously our pro forma ratios included 100% deductibles of intangibles which will be required by the Basel III rules once the deduction is fully phased in.

Therefore the improvement of approximately 100 basis points due to the phase-in will completely disappear by 2018.

On April 8, regulators released the 5% and 6% supplemental leverage ratio requirements for certain bank holding companies and insured depository institutions.

At the same time a notice of proposed rule making was issued to codify the calculation of the denominator of the SLR and in the NPR the ability to use a daily average of total assets is included which is positive for us.

But unfortunately central bank placements were not excluded.

We estimate that our pro forma Basel III supplementary leverage ratio under our interpretation of the US proposed rules issued on April 8 are approximately 6.4% at the holding company and approximately 6% at the bank as of March 31, 2014.

The improvement in the leverage ratios is primarily due to the temporary capital benefit for the intangibles, the more favorable treatment of unfunded commitments, the use of the daily average of total assets, and the issuance of preferred stock during the quarter.

Partially offsetting these improvements was a larger average balance sheet driven primarily by the higher level of client deposits.

Now we are pleased that the Federal Reserve did not object to the capital plan that we submitted in conjunction with the 2014 CCAR.

In line with our capital plan our Board approved the purchase of up to $1.7 billion of our common stock through March 31, 2015.

Additionally, we will seek approval from our Board in May to increase the second quarter common stock dividend to $0.30 per share up from $0.26 per common share that was declared in the first quarter.

Next I'll reference slide 16 where we detail a change in the presentation of our operating basis effective tax rate.

Beginning with the first quarter of 2014, we changed the calculation of the operating basis effective tax rate by reflecting the tax equivalent adjustment that is included in operating basis revenue.

This change has no impact on operating basis revenue, pre-tax earnings, or EPS.

We believe the change will better align our operating basis effective tax rate with our other operating basis metrics and will provide a more informative measure of the ordinary rate of tax generated by State Street business activity.

On this basis -- the operating basis, tax rate was 31.2% in the first quarter of 2014.

Before I conclude, I would like to address a question which may be on investors and analyst's minds regarding our expense outlook for the remainder of 2014.

Excluding the first quarter seasonal deferred compensation expense for retirement eligible employees and payroll taxes we expect that expenses will increase in the last three quarters of 2014 primarily due to annual salary increases which are effective in April.

We do expect to realize savings of approximately $22 million in 2014 from the staffing reductions announced today.

I would note that we expect to achieve the majority of the $22 million of savings in the second half of the year and then expect $40 million of annualized benefit in 2015.

Overall for the full year 2014, we continue to target 3% to 5% revenue growth and positive operating leverage.

While the environment continues to present challenges we plan to continue to focus on our top priorities, driving more revenue growth, investing in growth opportunities, controlling expenses and managing our strong capital position.

The expenses actions that we announced today reflect the current environment and put us in a better position to deliver on our goal to achieve positive operating leverage on an annual basis in 2014.

Now I'll turn the call back to Jay.

Thanks Mike.

Stephanie, Mike and I are now prepared to handle questions.

(Operator Instructions)

Your first question comes from the line of Glenn Schorr with ISI Group.

First one is a quickie, I just want to make sure I heard your comments right, Mike.

So on a fully phased in basis the capital ratios on the slide are about 100 basis points lower.

Still strong, is that correct?

That is correct, Glenn, in terms of the Basel III risk weighted, in particular.

Then just want to make sure that on, according to the [annuals] you had mentioned you still had some preferreds to issue.

I still wanted to make sure that is still in the cards.

Then an add on question to that is how you balance the capital efficiency benefits with the earnings dilution?

And I'm asking just because I see a lot of people short of their 1.5% bucket, but not issuing because you can't give back all the capital, what's the point?

Sure, Glenn.

The overall answer is our position on prefs has not changed since the investor day.

As we talked about it at investor day we do expect to add at least $500 million over time of prefs to get to that 1.5% which we view is optimal in terms of the Basel III risk weighted capital ratios.

Really the key question, when I say at least $500 million, the key is going be the supplementary leverage ratio since the prefs that we issue do count toward the SLR.

There is an incentive, there is an economic incentive over time for us to potentially have, issue additional prefs, which over the fullness of time we would expect to enable us to reduce the common equity that we have outstanding.

In terms of your question on timing that is obviously something that we are looking at and we will continue to review our options.

And again I would say that if we are really looking at this, in terms of long-term shareholder value, where it is a good trade to make the trade relative perhaps for common stock, and the dilution is something that we think, at this point is manageable, but it'd be factored into decisions going forward.

Last one is, this is a good thing.

The asset management fees are up more than the assets under management which I haven't seen in a long time; that is a good thing.

In the text it doesn't say that it is a performance fee, so is that just function of mix in selling higher margin product?

I would say you'll recall, Glenn, from our investor day, you know, we featured in the SSJ presentation that we have -- we are less concerned about pure AUM and more concerned about revenue per unit of AUM and we have intentionally focused on higher yielding products mostly through ETF vehicles.

And we continue to push those out and that's had the effect of improving the revenue per AUM which we think is good and we think we'll continue to focus on.

Okay.

Thank you.

Next question comes from the line of Ken Usdin with Jefferies.

Good morning.

Morning, Ken.

Mike, I just want to be super clear here.

When you are talking about expenses moving up off the first quarter base and you said excluding stock comp and payroll taxes, what is that explicit number we should use to build off of?

Thanks, Ken.

So what I would suggest, this is how I would suggest you think about it, Ken.

Is I would take the first quarter comp and employee benefits number.

I would back out the -- let me think about this for a second -- I would back out the $146 million of 55 and 5, the retirement eligible comp that's embedded in there.

And then I would think about adding approximately $21 million a quarter for the merit increases and importantly, as you go from Q1 to would Q2 we'll have an additional payroll day and that's worth about $5 million.

So that is how I would think about, I mean there are obviously other pluses and minuses, but I'm trying to answer your question in terms of how to think about the baseline.

I would make those adjustments as a starting point for Q2.

As I mentioned in my prepared remarks, while we will get savings in 2014, they will be from the expense actions, the reduction in force of a net 400 FTEs will get benefit from that in 2014, that's mainly in the second half of the year.

Then we get an additional $18 million in the full year 2015 that we don't get in the full year 2014.

Okay, I just want to confirm because you had said payroll taxes as well.

So, but the only thing we should really be backing out from the first quarter is just the $146 million?

Yes, and the $146 million includes the seasonal effect of the payroll taxes on everybody.

What we look to focus on, Ken, with that $146 million number which is apples to apples with $118 million the year before, is it's the deferred comp for everybody that's retirement eligible and the it's the seasonal bump up in payroll taxes that happens in Q1 you know, as a result of flipping over the calendar year, and FICA taxes and stuff starting back at a zero base.

Just because I'm getting the question a bunch of times, the severance charges are not in that 1085 number, correct?

That is correct, Ken.

Then the operating expenses were higher than the range that you have talked to in the past.

Can you give us some color on what your outlook is for that operating expenses number?

The other, sorry.

Other.

Yes, sure.

So the other operating expenses, Ken, first of all, continue to be very pressured by these regulatory compliance costs.

Again very consistent with what we've talked about at the investor day.

There is significant upward pressure on that number, relative to 2013 levels.

So in terms of the outlook for other operating expenses in 2014, it is going to be lumpy and it is going to be lumpy because of legal costs, it will be somewhat lumpy for regulatory compliance expenses, and actually lumpy as well because of securities processing costs.

So it is one of those it is very difficult to give you a quarterly number with a lot of confidence, because in any given quarter stuff can go bump and you know either be good or bad.

I would characterize the first quarter though as being roughly in line with what we are going to see on a quarterly basis over the course of the remainder of the year, you know, based on our current expectations.

But I'd say the big wild cards are really the legal expenses and also the regulatory compliance costs where there is upward pressure.

Okay, if I could just wrap a final one together.

You know, your revenue growth was 3.6%, pretty much in that range you have talked about.

And obviously you know the expenses were in the 5s.

Even if you back out that retirement eligible the expenses were still a growing 4.5%.

So trying to understand then with a negative operating leverage start to the first quarter, and the expenses still moving up from here, albeit with your modest amount of incremental saves you are getting, what is your level of confidence that this can flip in the next three quarters and get us to a net positive operating leverage when you think about revenues versus expenses?

It seems like there is still a bad balance here between expense growth and revenue growth.

Sure, Ken.

Very important question that you are asking.

So the overall answer is, we are continuing to set as a goal for ourselves, for the full year, positive operating leverage for full year 2014 versus full year 2013.

Importantly as we talked about the investor day, we are managing for shareholder value, which means that we are going to continue to focus on the strategic plan that we've talked about which is sure, we want to be the low cost provider in the core activities.

But it also means that we are going to also focus on being an innovator of value added services.

Which means we are going to continue to invest.

So in terms of some of the numbers that you talked about, I'll add some additional commentary there.

First we do recognize that the Q1 revenue results was at the lower end of our 3% to 5% range that we reiterated at the investor day.

Importantly, Ken, I would note that both the revenue and the expenses in Q1 looked nominally higher because of a weaker US dollar.

If you actually make it on a constant currency basis the 3.6 and the 5.8 that you referenced are really like 3 and 5. The point is we recognize that we did not get a lot of help from the revenue environment in Q1.

Now we do think there is some potential help we could get for the full year revenue outlook, so for example we may get some potential help from equity markets.

It was useful that equity markets now are higher than where they were at year end 2013 which was the basis of the original 3% to 5% estimate.

So that's useful.

We also have not yet seen a material improvement in FX volatility; we would note the FX volatility is still at significant cyclical lows.

We think there is some upside there.

We did see a little bit of help on sec lending spreads in Q1 and we expect more help in Q2 since that is the seasonal dividend [arm] quarter where it has tended to peak, so that should help.

Again if we could get some help from market interest rates in the second half of the year we think the revenue outlook could be better than the, call it, 3% that we saw on a constant currency basis in Q1.

Importantly Ken, I would just reinforce, if the revenue outlook continues to be very soft, we will continue to review our operating expense options.

Everything is on the table.

Again we are managing this for the long term, but we are also very serious about our goal.

Rest assured if we continue to see more 3% scenario than 5% scenario, we'll look harder at operating expenses.

Thank you for all that color Mike.

I appreciate it.

Next question from Alex Blostein with Goldman Sachs.

So just picking up on the last point I wanted to get into expenses a couple of specific items and maybe one or two on the revenues.

Mike, I think what you mentioned is regulatory related costs are still going higher.

That is something different that we heard from the other two trust banks.

Sounds like they are still elevated obviously relative to where they have been kind of the last couple of years, but it didn't sound like they are growing a ton from here.

Do you guys still expect that for State Street, I guess regulatory and legal related items will continue to grow in 2014 versus 2013?

Absolutely yes, Alex.

Again I won't comment on any other company's issues.

But I am virtually certain that ours will be higher.

And candidly, it will be a challenge for us to manage the year-over-year increase in regulatory compliance cost to the $30 million to $40 million that we talked about at the investor day.

There is real upward pressure on that $30 million to $40 million range.

Got it.

Thanks for that.

On the revenue front the two items I was hoping to spend a few minutes on are the brokerage and other, and the securities lending.

In brokerage and other, I understand there is a couple of things that go in there.

This line item has been kind of on a 120, 130 range, a year ago so and the last couple of quarters has been closer to 100.

So help us understand I guess what's been the biggest delta there?

Is it really all the GLD or there's been some softness in the transition management business as well?

And then just a quick follow-up on sec lending.

Okay, on the brokerage and other revenue, you are absolutely right, Alex.

That category for us is down $30 million versus Q1 a year ago.

A little over a third of that is the lower gold fees that we get mainly reflecting the lower price of gold but also outflows out of the gold fund.

The other, call it, $19 million is really a combination of as you said, lower transition management revenues, but also importantly lower electronic exchanging, excuse me, electronic exchange revenues.

Again we feel like we are well positioned in that market.

We see it really as a market phenomenon as opposed to a State Street specific situation.

Again if there is any silver lining to that dark cloud, it's that, that's another area where we view as potential upside, if in fact global economic conditions improve.

Let me pick up the securities lending fees?

I just want to get a sense on that is one of the bright spots I guess in the quarter.

Pretty good growth year-over-year.

And I think one of the things you talked about at the investor day is enhanced custody, and I think it was mentioned in your prepared remarks as well.

Was hoping you could either quantify I guess how much that new revenue stream has contributed if at all and maybe help us size the opportunity there.

Sure, it was a bit of a bright spot both sequentially and year-over-year.

First time in a while we have seen the on loan balances up nicely, 6% sequentially.

You did, you hit on the key element of the growth, which is in the quarter, 25% of our securities lending revenues was driven by enhanced custody, and almost all of the growth came through enhanced custody.

So I would just remind everybody that is something that we begin investing in three years ago and we are still investing in it, as we bring it into Europe and Asia, but we think is a nice addition and will represent a lot of the future of the securities lending business.

Thank you so much for taking the questions.

Your next question comes from the line of Ashley Serrao with Credit Suisse.

Good morning, I had a few clean up questions.

First on revenues, can you just size your current asset servicing backlogs?

And also what was the CVA benefit to [associating] fees this quarter?

The asset servicing backlog so committed non installed I believe is $136 billion.

And as for your other question I wasn't understanding.

He was asking, Jay, about the CVA.

The CVA was approximately plus $3 million in the quarter.

Roughly flat sequentially.

Okay.

Got it.

And just on expenses, I want to do, add another, basically complete the picture you painted, Mike.

Off the of the $130 million savings, how much have you realized so far this year?

Could you give us some color there?

Sure, Ashley.

I would characterize it as we have achieved the substantial majority of the $130 million and overall feel like the full year as well as the remaining $50 million in 2015 are on track at this point.

Got it.

Just finally, on the occupancy expense line, should we think of $118 million as a starting point ex the credit this quarter?

Yes, I would suggest to you that is a good idea.

Okay.

Thanks for taking my questions.

Next question from Brennan Hawken with UBS.

So the asset management fee rate, you know if we adjust gross it up for the fee waivers and adjust for performance and the day count, we were still down you know where it had been running the prior three quarters, was there anything specific?

I know it is up year over year versus where it had been in 2Q through 4Q.

Was there anything specific driving that drop?

Just to put some facts around it.

As I mentioned in the prepared remarks the performance fees are down $2 million sequentially and I would also add the day count cost us approximately $4 million.

So again that would be the main headwind.

We did get some help from a little bit lower money market fee waivers as we saw money move out of the government funds and into prime money market, which leads to a little bit better waiver experience.

And then some help from markets and also some help from -- a small amount of help from net new business.

Grossing up for all those, right?

I still had fee rate dropping from where it had been running.

So was there anything specific?

Was it just the flows out of the SPY given that's a higher fee rate?

So it was a mix function?

Or what was it do you think?

We did have some flows out of SPY.

That tends to happen at Q1.

That is a pretty common seasonality, seasonal pattern, excuse me.

But nothing unusual in the quarter.

I think it is fair to look at the year over year if you are considering trends more than the sequential quarter.

Okay thanks, Jay.

And then on those typical seasonal outflows on the SPY, you know this quarter it is $19 billion, last year it was $5 billion.

Is there anything that's causing that to be so much worse?

So much more pronounced than it was last year?

Because we don't see anything, any other big outflows out of other index products.

Just kind of curious whether or not you have any insights into what's making that a bit more seasonably severe this year?

No, I don't think there is anything unusual.

In fact after the quarter ended we saw a lot of that come back.

So I think it's used as a trading account at quarter end, and I think if we look back over several years, you would see there is a fair amount of difference in those flows.

But we are not reading anything other than, anything trend wise into it.

Perfect and helpful to hear it bounced back here post quarter.

And then last one for me just a really minor one.

The CVA, I think you guys highlighted the counterparty valuation adjustment in the processing fee.

Can you maybe size that for us?

It was approximately $3 million positive, Brennan.

Terrific and that is versus sequential or year-over-year?

Sequentially it is flat.

It was also positive 3 in Q4.

Q1 doing this from memory, I believe was minus $6 million so it would be a $9 million improvement on comparing those two quarters.

Terrific.

Thanks a lot.

Next question from the line of Luke Montgomery with Sanford Bernstein.

I guess I'm still confused by the slide and the asset servicing fees as a percentage of asset center custody.

I think you were asked about it at the investor day.

I get the context that less than 50% of those fees are directly linked to AUC, but I think you stopped short of really providing a detailed explanation of the dynamics that are at play there.

Maybe you could do that for us now.

I think we have seen better flow that the asset manager's portfolio turnover is finally picking up, so why is this line still falling?

What types of activities specifically are under pressure and are those cyclical or secular pressures.

Sure, Luke, it is Mike.

The transaction revenue is the main piece that I would ask you to factor into your analysis.

So specifically, transaction revenue was down $5 million sequentially Q4 versus Q1.

It is just lower market activity.

Believe me when I tell you, we have looked at it several different ways.

It just looks like it's driven by lower market activity going on.

So I would expect when we get into an environment where the global economy is a little healthier and there is a little more risk taking we would expect that to improve but I would certainly acknowledge we've seen it move in opposite direction now for three sequential quarters.

Just in time for me taking the job, of course.

And then a slightly more detailed question, maybe you could just touch on processing fees and other revenues.

I think there was some noise in this quarter.

I think the last time you said anything in terms of guidance was first quarter of 2012 and you pointed to $70 million, $75 million as a decent run rate, but then later you restated that line by about $35 million.

Would you be willing to say that $100 million to $110 million is a decent run rate for that line?

Luke, what I would suggest is if you include the tax equivalent adjustment that we detailed every quarter, which the recent increase there has been primarily caused by the higher volume of tax advantaged investments.

If you include that tax equivalent adjustment, I would expect that the processing fees and others would range between $125 million and $135 million a quarter for the remainder of this year.

Again importantly, including the tax equivalent adjustment.

Okay that is helpful.

Final one for me, at just high level.

Given that the scale assets managers have been earning sub par OEs for the last five years, I would imagine that smaller servicers are maybe even earning worse returns.

So why haven't we seen more competitors exit the business or merge?

Maybe you could discuss the dynamics that caused I think so many to hang on this business and then maybe what does that say about the benefit of having scale in the business?

Is your question pointed at asset managers or asset servicers?

Did I say asset managers?

I meant asset servicers.

Okay, it is huge advantages of scale.

I think they are getting even greater when you think about the imposition of regulatory and compliance costs that we referenced earlier.

You know I think the question of why isn't there more consolidation on the back of that?

You know, first off there has been a lot of consolidation.

If you look at the concentration in the asset servicing businesses there's four firms that have 70% of the market by I think industry calculations.

You know, you've got a series of banks, European banks that I think continue to view these businesses even though sub scale as attractive in some part because of the liquidity that they provide in an environment where those banks are under some pressure.

So I think that may run its course at some point in the future, but I don't see it changing in the short-term.

And the other category of service providers I would point to is if you look at the alternatives, asset servicing space, it's got a little bit more as far as volume of sub scale players, names that you know, many of you would be familiar with, and that's been, I think that is a market that proportionally has higher growth prospects and has experienced higher growth, so I think that's caused people to hang in there.

In summary I would say there is, because of the concentration and consolidation that's occurred up until now, there is less suspects for roll ups and for different reasons people are finding it still interesting being in the game.

I think the bar gets higher, you know, the need to drive efficiency out of the core operations, the need to address compliance and regulatory costs will continue.

And I think that puts pressure on sub scale providers.

Okay.

Thanks a lot.

Next question comes from the line of Gerard Cassidy with RBC Capital Markets.

Hi guys, this is actually Steven Duong in for Gerard, thanks for taking our call.

Just going back to the SLR, you guys had provided some color on the improvement sequentially.

Would you happen to have the break out of the percentage, on a percentage basis of the moving parts for that?

Sure Steven, it's Mike.

Let's focus on the bank.

Which went from 5% to 6%.

Yes.

And so specifically, I'm going to give you round numbers here.

The improvement that we got from the temporary credit on the intangibles is worth approximately half of that, so call it 50 basis points.

The combination of the moving to the daily average calculation, rather than the month end calculation, roughly offset the larger balance sheet we had in the quarter because of the spike up in excess deposits.

So you could size that plus and minus at about 30 basis points.

But those two things offset.

And then the benefit that we got from the improved conversion factors, under the rules, is worth approximately 30 basis points.

Then we had a bunch of other odds and ends that contributed 20 basis points.

That would be the roll forward at the bank from 5% do 6%.

Great, thank you.

Would you happen to have it at the holding company level at all?

Sure.

The -- it's approximately the same numbers.

The only other piece that you are going to want to factor in to that analysis is that the proceeds that we have from the pref issuance.

So they, call it $750 million from the proceeds of the pref issuance is worth, call it, another 25 to 30 basis points.

That is at the corp level and not at the bank level.

Right.

So when you issue your $500 million in pref, you would expect perhaps another say 15 basis points then?

That's correct.

Call it 20, but yes.

Okay perfect.

Just going back to your new business wins; do you have the breakout of what was outside the US versus US?

Yes, I think it was roughly 38% outside the US.

Which is consistent with a balance we've seen over the last couple of quarters.

Great.

That's all for us.

Thanks for taking our call.

Next question comes from the line of Betsy Graseck with Morgan Stanley.

Hi, good morning.

Hey a couple of questions.

One on expenses and one on revenues.

So on the expense side I noticed you have the merit increase coming this year.

I don't know if this is the right calculation.

We just look at it relative to total comp dollars, it looks like it is around a 2% hike.

Wondering how you think about sizing it because it feels a little bit you know higher than inflation right now?

And you know, it looks like it is not necessarily tied to performance.

Is that, so just wondering how you would size that number?

Yes, Betsy, it is Mike.

First of all we did average a 3% increase in base salaries that's effective in April and basically we did a review of the market conditions.

We've reviewed what other companies were doing, where our compensation levels were versus other key competitors, and key competitors, not just banks, but also just other people that we battle with for talent.

And yes, I would certainly acknowledge that the 3% is a fair amount higher than the last couple of years where we had very small increases, but again we thought it was important given the competitive landscape and the importance of keeping our top talent.

So if we see a little wage pressure here maybe we will get interest rates rising on the front of curve soon that would be nice.

That would be very helpful, Betsy.

Exactly.

Then just a second thing is on collateral transformation.

I just wondered, at the analyst day, investor day you highlighted some of the things you are doing to try to increase your share of you know, activity along the trading channels, doing more in PB related stuff doing more with collateral management and collateral transformation.

Could you give us a sense of where you are in this process?

Is this anything that we are going to see in the numbers you know in the next year?

Or this is more of a very gradual, over time five years down the road we look back and say hey this was the start of something big.

Betsy, this is Jay.

I would say it is the latter.

It would gradually bleed in over time.

I think collateral transformation is a product that we offer today where, ramping up slowly that activity across a number of customers.

Derivative clearing, probably a little more excitement going on, we are on the front end of signing up customers.

There is a little bit of a lead time to sign them up.

Once you sign them up you should see a pretty steady flow.

You know I think we are viewed as an attractive alternative in the derivatives clearing space.

Enhanced custody would be another product I would say is maybe indicative of what I would expect out of derivatives clearing and collateral management a couple years out.

It took us a year or so to get it set, get the infrastructure set, revenues started coming in.

But once they start coming in, they should be pretty sustainable and improving over time so it is the gradual enhancement to core revenues.

Okay.

Thanks.

Your next question comes from the line of Cynthia Mayer with Bank of America Merrill Lynch.

Hi, thanks a lot.

Just quick question on the assets under custody and administration levels.

It looks like you know, just looking at your page 3 of the main release that it went up 0.2%.

But the markets, in most cases, I guess other than EFA went up more than that.

And you guys do cite net new business.

I'm wondering in terms of levels, why wouldn't it go up a little bit more given your equity sensitivity?

Let me take that one, Cynthia.

Because there is a -- we did lose a customer that had low revenues and high AUA.

Let me just explain the situation, because it is unusual.

It was a customer we acquired through IBT back in 2006.

It's rare that we would do middle office without custody activities.

In this case we were doing middle office without custody activities and it had a pretty high AUA, and pretty low revenues.

It was a pretty simple middle office construct.

And in taking to the customer over the last couple of quarters, they concluded we agreed they would internalize it, so that really speaks to that abnormality, which I wouldn't, I would say was clearly a one off.

So can you, you know, give a sense of the size of that?

And I guess there is very little revenue impact you are saying?

Yes, $500 billion, which is where you are get the anomaly and pretty low revenue.

Again, just a simple, middle office only implementation.

Nowhere close to all of our other middle office implementations, but did create that distortion.

Okay.

And in terms of the new asset servicing mandates you are bringing in, how does the mix compare to what you have in place in previous quarters.

Any shift?

Is it similar?

In terms of the fees?

I wouldn't say it's similar, but it is heavily weighted in the alternative space.

You know, again, more hedge and private equity.

You know, you also see, we all see those alternative structures moving down market into some of the liquid alt structures.

I would say we should continue to expect to see, proportionately, more of our new business growth coming in those alternative categories.

Okay.

And then finally, the $40 million in cost saves you guys have cited, and the headcount cut, maybe you said this but where were those cuts and are there any offsets?

Like for instance the increase IT as you move to external service providers, is that related to the headcount cuts?

No I would say, Cynthia, the headcounts cuts were kind of broad-based.

No specific theme.

As we continue to mine the organization for efficiencies or things we can do in other places, we took advantage of that.

And are there any offsets in terms of you know, greater use of outside services?

No.

It's a straight reduction.

Okay great.

Thank you.

Next question comes from the line of Steven Wharton with JPMorgan.

Hi guys.

Morning.

I just wanted to, I think this question may have been asked, forgive me if it was.

What is the business, you know, the whole outsourcing and IT initiative cost saves objective for 2014 incrementally?

And what has been achieved cumulatively to date of the total you are trying to achieve through the end of 2015?

Sure, Steven it's Mike.

The goal for 2014 full year is $130 million.

Yes.

That would bring the cumulative to date to $550 million at the end of this year.

And there would be a remaining approximately $50 million that we would get in 2015.

$600 million in total.

Right.

And were you saying that through the first quarter you have already achieved the $130 million?

I would characterize it as not the full amount, but a majority of the amount.

If you then annualize the Q1 we would have achieved the majority of the annual amount.

Okay.

Basically, that's why to some degree you have announced this additional restructuring of sorts because you have basically run out of benefits from the outsourcing initiatives for this year and then there's maybe a little bit more in 2015?

Yes.

I mean again we did it for a variety of reasons, including the softer revenue picture, and the importance of our goal of achieving overall positive operating leverage for the full year.

Okay, thank you.

Next question comes from the line of Vivek Juneja with JP Morgan.

Hi Mike, hi Jay.

Want to reconcile one comment that you mentioned, the transaction related fees were down $5 million, transaction related revenues were down $5 million linked quarter.

But then when I look at your commentary in the release on transaction processes expenses, you say that those were up due to higher volumes.

How do I reconcile those two statements?

Sure Vivek, it's Mike.

They are even though they both had the word transaction in them, they are very different items.

So specifically, as I mentioned earlier, the brokerage and other revenue is driven by the combination of the lower gold fees, the SPDR GLD fees, as well as the pressure that we've seen on the electronic exchange revenue that is picked up in other trading services.

The transaction processing fees, those are mainly service bureau fees, and they are higher based on our higher volumes.

That, those kinds of volumes would tend to track more with our global service fee revenue, as opposed to any of the other line items.

So --

But the gold and other is showing up in processing and other fee, right?

Well the gold fee is driven by the volume of assets that we have -- Sorry, go ahead.

The gold and other is in the brokerage fees, whereas I'm referring to your asset servicing fees where you talked about transaction related activity being down.

And I'm reconciling, trying to reconcile that with transaction volumes being up in the transaction processes expenses line.

I'm sorry; I misunderstood your question, Vivek.

So again the transaction fees that we get as part of the GS revenue is down just because of lower market activity.

Things like the service bureau fees, that can include things like pricing, services, transfer agent costs, again, there are different volume drivers for the expense versus the transaction revenue.

Okay.

All right.

Let me re-ask one other question that was asked earlier.

The processing and other fees which went from 106 to 127, which you said the run rate would be 125 to 135, when I look at the tax equivalent adjustment that went from 53 to 57, so a lot bigger increase in the processing and other fees.

What is driving that and how sustainable is that?

Sure.

Again, I would suggest that you look at it in total.

Because part of the processing and other fees, if you exclude the tax equivalent adjustment is actually the amortization that we have on the tax advantaged investments themselves.

So that piece contributed three of the number that you are describing.

So I think of the tax advantaged investment as being up 7 sequentially, which is 4 from the tax equivalent adjustment and 3 from the lower amortization.

In terms of the rest beyond the 7, our JV revenue was up sequentially $8 million Q4 versus Q1 of 2014.

Again that tends to bounce around.

But I, I think the Q1 is pretty darn close to what we'd expect for the remainder of the year in terms of JV fees, but again with a caveat that it does bounce around.

We also had an uptick in portfolio transition services, specifically some currency risk management fees that we saw an increase in, and again I would characterize the Q1 as being a reasonable expectation for the remainder of the year.

So you know, in aggregate, Vivek, I would say that the processing fees and other, including the tax equivalent adjustment, a reasonable expectation would be 125 to 135 over the remainder of the year, with the slight growth that we'll see their mainly driven by higher tax advantage investments for Q2 and Q3 in particular.

Great.

Thank you.

Your next question comes from the line of Jim Mitchell with Buckingham Research.

Hi, good morning.

Just want to follow-up on your NIR outlook and the balance sheet.

You had a bigger spike in deposits in the balance sheet than your peers.

I guess number one, could you maybe, if you have any insights on what drove the spike?

And secondly, embedded in your NIR outlook what is your view?

What is the embedded view of your balance sheet for the rest of the year?

Thanks.

Sure Jim, it's Mike.

I'll start.

First we did see an increase in excess deposits in Q1 versus Q4.

We estimate that they were up approximately $3 billion in terms of average daily balances Q1 versus Q4.

They spiked significantly at the very end of the quarter.

And I view it as really a function of the fact that we are viewed as a safe haven, and also that there are not other great alternatives for our clients to put, you know, very short-term money in.

At this point in time.

Was that coming from out of Europe or the US?

It is actually both.

Okay.

It's both.

So again, you know, if you look at any particular client, there is a different story for each client.

But it is a global phenomenon at this point.

In terms of what do we think the size of the balance sheet would be over the course of the year, the short answer is -- if short-term interest rates do rise, we do expect the majority of our excess deposits that are on our balance sheet would likely leave and find other places where they could earn better yields and that is embedded in our NIR forecast that we gave under that scenario.

Remember Jim, I would you ask to remember that this is very low margin business.

We take these excess deposits from our clients and put them with the big central banks.

Again we are earning round numbers call it a 20 basis point NIM on that, on those assets.

It is not a big mover in terms of net interest revenue over the course of the year.

Excluding the impact of the excess deposits I would expect that we would have essentially stable to perhaps modest growth in the core operational deposits over the course of the year.

The big mover in terms of the overall size of the balance sheet will likely be the excess deposits.

Okay great, thanks.

Your final question comes from the line of Robert Lee with KBW.

Thanks for taking my question.

I apologize up front for asking -- for this, I wanted to go back to asset servicing, I'm trying to wrap my head around the idea of the lower activity.

Because when you look at a lot of things out in the market place whether it's fund flows, whether it's mutual alternatives, whether it's even I guess I would characterize even higher sec lending balances as it being some indication of leverage and risk taking.

And then kind of also layer on top of it that maybe you are being impacted in asset servicing by lower customer activity.

You know a couple of things, how much of that may be being impacted by a pension movement towards the LDIs?

Is that having a negative impact on that business that is discernible and should we be thinking that maybe that business maybe take to a point you made on emerging markets that actually maybe it's more leverage to emerging market flows, and things like that, that maybe we would perceive from the outside?

Really just trying to get a little more granular on it.

Let me start with a couple of facts.

And then I'll ask Jay if he wants to add.

So in terms of the transactional revenue, that's embedded in our global service fees, those were down as I said earlier, down $5 million sequentially and down $3 million versus Q1 of 2013.

We have sliced and diced it.

I mean, just truly, it looks like simply lower market activity.

And unfortunately, has been a continued trend that we've seen now for three straight quarters.

I think there is potential for that to improve when we see a little more global market activity.

But again, those are the facts.

Let me see if Jay wants to add.

I don't know what I could add other than it does reflect the portfolio managers who are part of the customer base we service there, velocity of trading.

And you know, as you know, proportionately, we are greater in the funds business and the alternatives business, less so proportionately in pensions and corporates.

So I can't put my finger on anything other than, you know, just lack of trading volume.

I think to me, the service fees, in addition to the actual trading activity, you know, are being affected as much by kind of muted market activity, you know, pretty slow growth in the equity and fixed income front, and lack of risky investments are as much a drag on that service fee line as the transaction volume itself.

I appreciate it thanks for taking my question.

Stephanie is that it?

Yes, sir.

That is your final question, sir.

So thanks everybody, we look forward to getting on the phone with you again at the end of the second quarter.

Thank you.

Thank you, this concludes today's conference call, you may now disconnect.