道富銀行 (STT) 2014 Q3 法說會逐字稿

Good morning and welcome to State Street Corporation's third-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 or rebroadcast or distribution in whole or in part without expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on State Street's website. (Operator Instructions).

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

Thank you very much, Stephanie. Good morning, everyone, and welcome to our third-quarter 2014 earnings conference call. With me on the call is Jay Hooley, Chairman, President, and CEO, and Mike Bell, our Chief Financial Officer.

Prior to discussing our agenda, I would like to take this opportunity to invite our institutional investors and analysts to join us for a 2015 annual investor and analyst forum in New York City on Wednesday, February 25. We have chosen this date as it is our confirmed understanding that one of our larger peers will be holding their investor day the day before, on Tuesday, February 24, in New York City. We look forward to seeing you there, if not before.

Now to our agenda. Jay will discuss the third-quarter highlights and Mike will discuss financial results. Our third-quarter earnings materials include a slide presentation. Unless otherwise noted, all the financial information discussed on today's webcast will reflect our 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 in other related materials, such as the slide presentation referenced on this call, can be found in the investor relations section of our website.

Mike Bell will refer to the financial highlights presentation when he provides an overview of our financial results for the third quarter of 2014, which he will refer to as 3Q 2014, and for the nine months ended September 30, 2014, which he will also refer to as year-to-date 2014. Unless noted separately, Mike will reference only the non-GAAP operating-basis results in his comments today. When reviewing our results in comparison to prior periods, Mike will primarily focus on comparing our 3Q 2014 and year-to-date 2014 performance relative to our third-quarter 2013 and nine-month year-to-date 2013 performance, unless he otherwise notes that the comparison is sequential from our second-quarter 2014 results.

Before Jay and Mike begin this discussion of our financial performance, I'd like to remind you that during this call, we will be making forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in State Street's 2013 annual report on Form 10-K and subsequent filings with the SEC. We encourage you to review those filings, including the sections on risk factors, concerning any forward-looking statements we make today.

Any such forward-looking statements speak only as of today, October 24, 2014. The Corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

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

Good morning, everyone.

Before I begin my remarks, I'd like to take a moment to welcome to State Street our new head of HR, Anthony Ostler. Anthony recently joined us and has over 22 years of financial services experience.

Now to my remarks. Our third-quarter results demonstrated good core fee growth in asset servicing and asset management, which together were up 9% from the third quarter of 2013, reflecting improved equity markets and new business commitments. Our market-driven revenues also performed well in a traditionally seasonally slow quarter. Our pipelines are strong, as evidenced by winning new business of $302 billion of assets to be serviced, and we had $2 billion of net new assets to be managed this quarter.

On the expense front, we continue to be very focused on controlling costs across our organization. As we have highlighted for you on the past couple of conference calls, we continue to experience increased pressure from regulatory compliance costs and would expect these pressure to continue in future periods. Despite the current challenges we face from low interest rates, we have leveraged our strong market positions and capabilities to generate profitable topline growth.

Now I'd like to provide a brief overview of economic and market developments and how our business was affected. For the third year in a row, the third quarter has seen economists downgrade their forecast for global growth from -- for the current and coming year. While not uncommon, this quarter's adjustments have had -- has had a number of important consequences.

Global commodity prices have fallen. This has put further downward pressure on already falling global inflation rates. In what has been a very uneven global recovery, this means that deflation has returned as a clear and present danger in a number of economies, especially in the Eurozone.

This has already created a good deal of policy uncertainty. The ECB cut its administered rates on September 4 in response to mounting pressure to further address the region's weak growth and low inflation. Additionally, the ECB also began injecting liquidity into the system, putting further downward pressure on market rates.

In light of the ECB's decision to reduce deposit and administered rates, we have notified our clients of the potential to charge negative rates or fees on euro deposits. Our plan, which is similar to many other banks, is to begin charging later this quarter.

In contrast, the response of the Fed to the global slowdown is less clear. Most still project a Fed tightening next year, but the timing and scale of rate rises is now a key point of uncertainty. Nevertheless, on balance, monetary policy in the US and perhaps the UK will likely diverge in 2015 from the continued easing expected in both the Eurozone and Japan. These economic divergences and uncertainties appear to have contributed to the return of volatility across assets.

Geopolitical factors have also played their part.

At the start of the third quarter, volatility across most financial markets was at historically low levels. Several central bankers voiced concern about this complacency, as it potentially reflected the underpricing of risk. There is less cause for this concern now. Volatility has risen consistently across assets, a trend that has continued into the beginning of the fourth quarter.

Together, these trends impact our business lines in two different ways. First, the growth downgrade and disinflation risk means the low interest rate environment looks likely to stay for a while longer. This continues to negatively impact our net interest revenue and net interest margin as higher yielding investments mature, pay down, and have to be reinvested in lower yielding investments currently available in the market. We also continue to experience high levels of deposits and, for liquidity reasons, maintain those that we view as excess with central banks.

Another short-run implication of the environment is that the low rates have continued to impact the spreads associated with our securities finance business.

Second, the benign conditions at the beginning of the third quarter seem to have buoyed asset values and flows into emerging markets. However, those flows reversed in September as the growth scare impacted risk appetite. This was somewhat offset by the return of volatility in foreign exchange markets.

The economic divergence between the US and most of the rest of the world also led to a strengthening of the US dollar in the second half of the third quarter.

These factors, along with heightened risk aversion and an increase in currency market volatility, boosted both volumes and FX trading revenues in the third quarter of 2014.

Now I'd like to talk about the growth of our asset servicing and asset management business. Our third-quarter 2014 new asset servicing wins totaled approximately $302 billion, representing a range of clients and sectors. 38% of those assets were from outside the US. Also included in the new business were 32 new alternative asset servicing mandates.

New assets to be serviced that remain to be installed in future periods totaled $250 billion at quarter-end and our current pipeline continues strong.

In our asset management business, we experienced net inflows of $3 billion for the third quarter. The flows were driven by net inflows of $7 billion into ETFs and $1 billion into cash funds, partially offset by net outflows of $5 billion from largely passive fixed-income institutional mandates.

Our success in new business commitments across our franchise reflects our efforts to develop continued focused solutions through continuous innovation. Given our client focus and ability to differentiate our offerings, we expect to build on our new business momentum for the rest of the year.

Now I'll turn the call over to Mike, who will review our financial performance for the quarter and outlook for the balance of the year.

Thank you, Jay. Good morning, everyone.

Before I begin my review of our operating business results, I'd like to comment regarding the $70 million pretax, or $53 million after-tax, nonoperating charge recorded in the third quarter. This charge reflects our intention to seek to resolve some, but not all, of the outstanding and potential claims arising out of our indirect FX client activities. This charge pertains to indirect FX matters which we have disclosed over the past few years, and it's important to understand that we do not currently intend to seek to negotiate settlements with respect to all outstanding and potential claims.

In addition, our current efforts, even if successful, will address only a portion of our potential material legal exposure arising out of our indirect FX client activities. As I'm sure you can appreciate, settlement discussions are confidential and we are not able to make more specific comments on those matters at this point.

Now turn to slide nine and note that we are pleased with our year-to-date 2014 EPS, which has increased approximately 10% relative to 2013. Year-to-date 2014 core servicing and management fee revenue increased approximately 8% compared to the same period in 2013, benefiting from both higher equity markets and net new business. As a result of the strong fee growth, year-to-date 2014 total revenue increased approximately 5%, despite the downward pressure on net interest revenue from low market interest rates.

Third-quarter 2014 EPS was $1.35 per share, down from second quarter, but up from third quarter of 2013. The decrease in EPS from second quarter primarily reflects lower revenue related to securities finance seasonality and a higher tax rate this quarter, partially offset by the benefit of our share repurchase program. Compared to the third quarter of 2013, EPS increased primarily due to strong growth in our core servicing and management fees, as well as the benefit of our share repurchase program.

Total revenue increased slightly from second quarter, even with the seasonal decline in securities finance revenue, and it increased 8.5% from the third quarter of 2013.

Overall, expenses were well controlled in the third quarter, although the results included the benefit from the US dollar relative to second quarter of 2014. The third-quarter 2014 operating basis effective tax rate was 31%. We currently expect the full-year 2014 operating basis effective tax rate to be in the range of 30% to 31%, which implies an expected fourth-quarter 2014 rate of approximately 32%.

Now I'll discuss additional details regarding our operating basis quarterly revenue, as outlined on slide 12. Unless otherwise noted, my comments here will focus on the comparison of third-quarter 2014 to third-quarter 2013. I believe this is more relevant, since the sequential-quarter comparison includes the effect of the seasonal pattern in securities finance.

Importantly, servicing fees continue to perform well, up approximately 8% year over year. This reflects stronger global equity markets and net new business.

Third-quarter 2014 asset management fees increased 14.5% from third quarter of last year, primarily due to stronger global equity markets, net new business, and higher performance fees. Money market fee waivers were $11 million in third-quarter 2014, which was relatively flat. Trading services revenue increased 5%, reflecting the continued success in our foreign exchange trading, which generated higher revenue as a result of increased volumes, partially offset by lower volatility. Securities finance revenue increased approximately 34%, primarily due to higher volumes in both our enhanced custody and agency businesses.

Processing fees and other revenue increased from a year ago, primarily due to higher revenue associated with our tax-advantaged investments and other fees, partially offset by some valuation adjustments.

Our net interest revenue also increased from third quarter of last year, benefiting from a higher level of interest-earning assets. I would note the third-quarter 2014 net interest revenue also included a $5 million benefit from the prepayment of a corporate bond.

Net interest revenue and net interest margin continue to be pressured from the persistent low interest rate environment and the reinvestment of the portfolio into high-quality liquid assets to meet the new liquidity requirements.

Now many of you have had questions regarding the European Central Bank lowering the overnight deposit rate to negative 20 basis points and the related impact on our deposit pricing. As market interest rates have continued to drift lower, we've notified our clients on the potential for us to charge negative rates or fees on euro balances. And as Jay described, our plan is to begin charging for negative rates later this quarter.

Based upon our current assessment of market conditions, we expect operating-basis net interest revenue for 2014 to be near the high end of the $2.25 billion to $2.28 billion range that we previously communicated on our second-quarter conference call. This estimate reflects a decline in net interest revenue relative to the third quarter of 2014 actual result, due to the impact of low market interest rates and the impact of increasing our HQLA to comply with the liquidity requirements. It also incorporates our estimated impact of the unfavorable interest rate environment in Europe.

Now moving to slide 13, I'll provide some comments on operating-basis expenses. Compared to third quarter of 2014, our total operating expenses increased approximately 7%, primarily reflecting new business support, higher regulatory compliance costs, higher transaction processing and occupancy expenses. In addition, third-quarter 2013 expenses included the impact of lower employee benefit expenses, resulting from plan changes, and a $30 million benefit related to Lehman Brothers related gains and recoveries.

Compared to second quarter of 2014, our total third-quarter operating expenses benefited by approximately $16 million due to the impact of a stronger US dollar. Third-quarter 2014 compensation and employee benefits expenses decreased from second quarter, primarily due to the impact of a stronger US dollar and lower incentive compensation costs. Additionally, third-quarter 2014 includes a $4 million credit related to a pension adjustment.

Transaction processing expenses were higher than second quarter, primarily due to higher equity values and higher servicing volumes. Occupancy expenses of $119 million increased 3.5% compared to second quarter, due to a one-time recovery of $5 million last quarter. Third-quarter 2014 other expenses included a $20 million contribution to our charitable foundation, partially offset by a $15 million insurance-related recovery. In addition, third-quarter 2014 other expenses were lower, due to some delays of external consulting expenses, which we now expect will be spent in fourth quarter of 2014.

Now I'll provide comments on our September 30 balance sheet. As you can see on slide 14, our overall approach to managing our investment portfolio has evolved to reflect the impact of complying with emerging liquidity rules, which is most evident in the $8 billion of US treasuries that we purchased in third quarter of 2014. We intend to be in full compliance with the liquidity coverage ratio requirements by January 1, 2015. Our interest rate risk position also reflects the impacts of our actions to comply with the LCR rules and we remain comfortable with this risk position.

Additionally, the after-tax unrealized mark-to-market gain as of September 30 was $411 million, which is lower than June 30 due to a modest increase in market interest rates, partially offset by an improvement from narrowing spreads.

Now turn to slide 15 to review our capital position. Our capital position remains strong and that strength has enabled us to deliver on our key priority of returning value to shareholders through dividends and common stock repurchases. As of September 30, 2014, our holding company Tier 1 common ratio, under the current Basel III advanced approach, was 12.7%. Under the Basel III standardized approach, which will not go into effect until 2015, our holding company estimated pro forma Tier 1 common ratio was approximately 10.9%. We estimate that our Basel III supplementary leverage ratios under our interpretation of the final US rules are approximately 5.7% at the holding company and approximately 5.4% at the bank as of September 30, 2014.

Now generally speaking, our capital ratios were lower in third-quarter 2014 versus second quarter. The main contributors to the decline were a larger average balance sheet, driven in part by higher levels of client deposits, and the reduction in common equity from the impact of a stronger US dollar flowing through foreign currency translation.

Now as I mentioned, returning capital to shareholders continues to be a top priority. During third quarter of 2014, we purchased approximately 5.8 million shares of our common stock at a total cost of approximately $410 million, resulting in average fully diluted common shares outstanding of approximately $430 million for the quarter. As of September 30, 2014, we had approximately $880 million remaining on our current common stock purchase program, authorizing the repurchase of up to $1.7 billion of our common stock through March 31, 2015.

So by way of summary, third-quarter 2014 results were driven by the strength of our core servicing and management fees and positive momentum in creating services. Core servicing and management fees grew 8% compared to year-to-date 2013, which demonstrates our success in the market. Despite the headwinds on our net interest revenue, we are well positioned to achieve our full-year 2014 operating-basis revenue growth target of 3% to 5%.

On the expense front, we continue to feel pressure from higher regulatory expectations. And in addition, we continue to believe that our common stock repurchase program, combined with dividends, is the best way to return value to shareholders.

So prior to wrapping up, I thought I would address a question that is likely to be on investors' and analysts' minds, and that is what is our outlook for fourth-quarter 2014. Fourth-quarter revenue performance could be impacted by overall market conditions in the quarter. In addition, as I mentioned earlier, we expect fourth-quarter net interest revenue to decrease relative to the third-quarter 2014 results. We currently expect fourth-quarter 2014 expenses to be higher, due to continued upward pressure on our regulatory-related costs and the delayed timing of some expenses from third quarter. Nevertheless, our goal is to generate positive operating leverage for the full-year 2014, although the fourth-quarter market conditions pose risks that are not completely in our direct control. And with that, I'll turn the call back to Jay.

Thanks, Mike. And Stephanie, we are now -- Mike and I are now available to open the call to questions.

(Operator Instructions). Ken Usdin, Jefferies.

Just wondering if you could talk about the two core fee businesses in a little bit more depth. In services, first, you had a modest growth and I'm just wondering if you can help us understand the impact of FX, and also just a commentary on the transaction activity this quarter versus last.

Let me start that, Ken, and Mike will pick it up. As far as core services, I'd start with the custody service fee base, which was up nicely year over year, up a little bit quarter to quarter, a reflection in order of priority of markets and we continue to see strong new business growth. We posted $2 billion of new committed business this quarter; there's $250 million still to install. So we've had a couple nice quarters of good momentum in the marketplace.

Let me just bridge into foreign exchange, which was another positive performer in the quarter. So, a few things. The volumes and volatility were a helper in the third quarter, and I would say volumes consistently, volatility really moving from front to back of quarter improved, September in particular, given the things that I noted.

I would also broaden it out to say that to us, foreign exchange is a pretty wide variety of service capabilities which we provide both to our custody customers, as well as our non-custody customers. And we continue to see good momentum in, I would say generally, the electronic trading part of foreign exchange, FX Connect, [current x], and, more recently, Street FX, which is the hourly priced against an index.

And even more recently, in September, we introduced a new FX vehicle called TruCross, which is designed to allow those that don't want to trade against the WM fix to -- basically, it's a trading platform, buy side to buy side.

So I would say market environment was good, particularly towards the end of the quarter, and generally volumes were pretty consistent across all platforms. Mike, I don't know what you'd add.

Just I'll add a couple of other facts just to support your quarter-over-quarter analysis.

So relative to second quarter, the stronger US dollar depressed our service fees by $10 million. So if you had done it on a constant currency basis, rather than $1.302 billion, it would be $1.312 billion, if you used constant currency.

In addition, the transaction revenue was down $4 million sequentially. Obviously, we got a little bit of help from markets, although they were pretty sideways if you include Europe. So as you can see, the underlying net new business revenue was very helpful in the core GS business here in Q3.

As it relates to management fees, as I said in my prepared remarks, the main benefit that we got there relative to second quarter is a combination of positive net new business, as well as performance fees. There, the FX impact was negative 2, from a sequential standpoint, and in grand total for our revenues, so inclusive of the $12 million I just talked about, FX hurt revenue by approximately $21 million relative to Q2 and had a little bit less than that impact on the expenses Q2 to Q3.

Okay, great. And my second question is just your commentary on the pushout in some of those consulting costs into the fourth quarter. Can you help us understand what didn't get spent this quarter and the type of magnitude that you're talking about from a third-quarter to fourth-quarter overall increase in expenses?

Sure, absolutely, Ken. This mainly relates to the timing of our regulatory compliance spending, so it's mainly outside consultants.

And so, basically, where we expected to spend on outside consultants in Q3, we expect that now still to be spent, but delayed into Q4. And I would range that in the, call it, $10 million to $15 million kind of range.

Now I would emphasize the other operating expenses category, as I've talked about in the past, can be pretty lumpy because we can add some, for example, some legal costs in there, and even the outside consulting spend tends to be pretty lumpy. But that was what I was referencing.

Okay, got it. So overall expenses, you're still -- and sometimes you typically have like a true-up, maybe, on the comp side, but are you trying to also say that you expect overall expenses, then, to be distinctly higher in the fourth or just that portion of it?

We do expect it to be distinctly higher. So the guidance that I had given at Q2, where we thought that Q3 would be $20 million higher than Q2 and Q4 would be $20 million higher than Q2, in aggregate there really has not been a change in our expense view, other than, number one, with the stronger US dollar, we got a $16 million benefit in expenses in Q3. Obviously the Q4 benefit, if the US dollar continues to be strong, will be what it will be relative to Q2. But the currency helped the expenses $16 million in Q3. And then, as I said, the timing between the two quarters will reflect the delay in the spending that I just mentioned.

Understood. Thanks, Mike.

Ashley Serrao, Credit Suisse.

Mike, just hoping you could flesh out where you stand on LCR today and just your latest thoughts around preferred issuance.

Sure. Good morning, Ashley. Regarding LCR, as we've talked about previously, we do expect to fully be in compliance by year-end with the Fed's expectations. And we estimate that if we calculated that LCR as of September 30, we would be in excess of the 80%.

Now I would tell you that following up on a question you asked me last quarter, Ashley, the final Fed expectations regarding the actual calculation of operational deposits is not entirely clear. It's slowly getting clearer, but not entirely clear. And as a result, following up on the question you asked me last quarter, at some point we will need to firm up the overall impact on our NIR. I would expect it to be modestly higher impact than what we had communicated previously, but we will have some more information on that in 2015.

As it relates to the prefs, first of all, no change in our view that for the risk-based capital ratios, we would ultimately want to get to 1.5% at a minimum of our overall capital structure being pref. So that would equate to approximately $1.8 billion, so that means we would need another $500 million at some point relative to the balance of prefs that we have currently.

So just looking at the risk-based ratios, no change in our expectations. The wild card continues to be around compliance with the supplementary leverage ratio. And since at this point, it still looks like the supplementary leverage ratio will likely be our binding constraint, I would say that it's likely we will go beyond the $1.8 billion that I just referenced and ultimately issue more prefs than that. Again, at this point, I wouldn't give an updated number or an update on timing, but that continues to be our thinking.

Great, thanks for the color there. And then, just on the current reinvestment environment, I appreciate the guidance for this year. But just maybe a sense around what the reinvestment yields are in the US versus Europe, and then any thoughts on what a flatter yield curve means for your revenue sensitivity would be appreciated.

Sure. As you can imagine, it's a little early to talk about 2015 because there's so many different moving parts going on there.

Obviously, if we got to a flatter yield curve by an increase in short-term interest rates, we would view that as a very positive thing, particularly given that we've got about one-half of our portfolio is invested in floating-rate securities, so an increase in short-term rates would be very helpful.

I would also reiterate that we would particularly benefit from the first, call it, 50-basis-point increase in -- the first 25-basis-point of increasing short-term rates would likely accrue very heavily to our benefit, but even the second 25-basis-point increase would also help us. So if we get a flat yield curve by a rise in short-term rates, that would be a very good thing.

As it relates to Q4, we've got some obvious headwinds. We've got -- first of all for Q4, you're going to want to back out the $5 million benefit we got in Q3 from the prepayment on that corporate bond. So I'd do that right off the top.

But then we've got three other items that are dragging down our expectation for NIR in fourth quarter. They are, number one, Europe, as you just mentioned. The market interest rates in Europe have dropped between 20 and 25 basis points at the short end over the last five months. The ECB has obviously cut the rate from zero now to minus 20 in that same period. So as Jay talked about, we are working to pass along that cost to our clients. But that will still be a headwind for Q4.

In addition, we have now the higher level of HQLA. That's going to be a drag because we are obviously not earning any spread on the HQLA.

And then, third is just the normal grind as the portfolio matures and rolls off. So as the result of all those things, we expect Q4 to be lower than Q3 from an NIR perspective. I think it's too early to try to speculate on 2015.

Great. Thanks for all the details there, Mike.

Glenn Schorr, ISIS.

Just ISI, thank you. I don't have Ebola, either.

So just one point on the clarification of the 4Q costs. In a standing steady-state world, currency neutral, fourth quarter from third quarter, we might add back that $16 million benefit on currency, the $10 million to $15 million catch-up on the delayed consulting costs, and then another $20 million on top for what was already planned on the consulting costs? I just want to make sure I have that right.

That's fair, Glenn. That probably puts more precision on it than it is warranted because, again, some of those other operating expenses are pretty lumpy. But directionally, you're thinking about it just fine.

Okay. And then on the regulatory question, we think of them as having a big seasonal component because, basically, June through December is hot and heavy. Or is this an annual run rate thought process? In other words, should we get a benefit in first quarter as CCAR is done and you take a breath?

Unfortunately, Glenn, there are a lot of moving parts to answer your question. You're certainly right that I would expect CCAR-specific costs, particularly outside consulting expenses, to decline in Q1 of 2015.

But unfortunately, CCAR is just part of a wide horizon of regulatory expectations. So I think it's a little early to speculate on Q1 2015 or even full-year 2015 regulatory compliance costs. We are in the midst of the budget process, as we speak. Again, a lot of moving parts, just to give you a flavor for it.

First of all, as I've said before, we are seeing regulatory expenses -- regulatory expectations be higher in a number of different areas, not just CCAR, so that's putting some upward pressure on expenses. On the other hand, we do expect over the course of 2015 to be able to reduce our reliance on outside consulting expenses and ultimately replace that more with full-time employees. So we expect to get some cost arbitrage there.

So again, a little early to try to conclude on 2015 at this point.

Okay. And then, maybe just a very high-level thought because it's so new. CCAR stress test came out last night, and I would just say particular to you guys, balance sheet has grown 27%. It's helped offset some of the NIM compression. But the test specifically has wider credit spreads and a flatter curve relative to last year. Is this just a little bit worse? Is it a lot worse? I'm trying to get your gut reaction, given the importance of that part of the test for you guys.

Obviously, we've had less than 24 hours to fully digest it and to run it through our models and such. But I would characterize it as modestly worse than last year's, but again with the caveat that I'm sure there will be some other devils in the details.

But particularly the fact that the equity market decline would be higher than last year would be a particular area, given our concentration in terms of our clients on equity assets.

Got it. Thanks very much.

Alex Blostein, Goldman Sachs.

So bigger-picture question, I guess, when we think about State Street's exposure to Europe. You guys clearly have significant business there and there is a number -- there's [not a lot] of places, obviously, where it hits the P&L, both on the NIR side with respect to securities rolling over, but also as you kind of translate from euros to the dollar. As we think about the enterprise as a whole, strengthening dollar, I'm assuming it's not a great thing. But maybe you can flesh that out a little bit more and give us a sense of, from a pretax dollar perspective, what the sensitivity could be.

Let me start that because I think it has -- there's a revenue side to that and there is an expense side. And Mike can pick up the currency effect, as well as the effect potentially on the portfolio.

But from a revenue side being our ability to generate servicing fees and management fees, really unaffected. If anything, neutral to positive, I think. If you look at our new business momentum over the past several quarters, Europe has been a little bit of a bright spot. And I would even go a little deeper to say if you look at flows, which is the other element of -- a critical element of organic flows, the offshore markets continue to perform exceptionally well, Ireland and Luxembourg where we have deep presence.

So from a standpoint of the fee revenues, I don't really see the fact that the Eurozone continues to have difficulties affecting that. In fact, if anything, it's a little bit positive. But Mike, why don't you talk about the --

Alex, first from a P&L standpoint, I would characterize this as being relatively neutral to the FX changes because, roughly speaking, it's not perfectly accurate, but roughly speaking, our revenue in different currencies tends to match our expense structuring different -- in different currencies. So I would characterize this as roughly neutral there.

As it relates to the impact on our capital levels, we are modestly exposed. I wouldn't characterize it as material, but we are modestly exposed to the fact that we've got some capital in non-US currencies. And therefore, and that's really weighted a little more heavily than, for example, the risk-weighted assets in those same currencies.

So as an example, what we saw at the end of the third quarter was when the euro weakened so much relative to the US dollar, we saw an impact on the September 30 currency translation, and therefore that negatively impacted our capital ratios at Q3. Once again, I don't view that as a long-term threat. But I do view it as a source of fluctuation that can go either way quarter to quarter.

Got it, thanks for all that detail. And then the second question is -- and I appreciate the fact that it's still probably quite early, but as we think about NSFR and the way it could impact the broader securities lending industry, I was just hoping to get your thoughts on your business with respect to, A, your growth in enhanced custody (inaudible) does use a little bit of a principal business for you, but also the secondary impact in kind of your core agency business.

So let me start that. Mike noted that our securities finance business this quarter was particularly healthy when you contrast it against last year's same quarter. And the growth was driven by better loan volume overall. I would say of the growth, two-thirds of it, roughly, was enhanced custody versus the agency business. So generally, good strength in the securities lending business. I don't see that abating.

I think the question was to the NSFR. In our enhanced custody business, we have found ways to minimize the capital effect through netting with the counterparties that we are lending securities to, which has resulted in a pretty capital-efficient trade. So as we look at enhanced custody, which is a business that we see -- not only have seen good growth in, but we see the prospects for even increased growth, we think it can be done on a reasonably capital-efficient basis. Mike, would you add to that?

The only thing I would add -- Jay is exactly right. The only thing I would add is that I do expect that prices will likely increase in that market, particularly for those clients where we can't reach netting agreements with them.

And I don't think that will be just us. I think that will be a phenomenon across the marketplace. So our early read is exactly what Jay said. We do expect this to be an attractive business for us from a capital-return standpoint over time, particularly with netting.

Understood, thank you. Thanks so much for all the color.

Luke Montgomery, Sanford Bernstein.

Good morning. Just following up on Alex's question. I was curious if you could elaborate on what appears to be a little bit of improvement in securities lending. You seem to think that's maybe a little bit durable, but perhaps you could address what you've seen in terms of structural changes since the crisis, what types of splits you're getting with clients, the level of participation in your programs, and the demand for activity related to collateral versus special lending.

Let me start that again. If I take it up and broaden it, the participation in securities lending from a customer standpoint has been stable to maybe slightly up.

So we've come through a long cycle over the past six years of people leaving the program, then rejoining the program. And that's been pretty stable, if not -- if anything, it's a plus, some adds.

If you look at the -- the other thing you would look at would be on loan balances, which have been over the past couple quarters running at about $350 billion, plus or minus. Within that, the loan growth has been good, and the attractiveness of spreads, particularly driven by merger and acquisition activity driving specials, again, has been a positive in the last couple of quarters.

You asked about structural changes. The one that comes to mind most to me is this decrease in leverage that the banks are going through, and as a result, we have seen the prime brokers be a little bit more selective about lending, which has really opened a window for that enhanced custody business that we frequently talk about.

So I would say if you look at sustainability, durability of trends that are going on, you can make your own judgment about whether the M&A activity will continue to be robust, but other than that, I think I would say it looks pretty durable from the standpoint of trend.

The only thing I would add is just thinking about it from a quarter-to-quarter perspective, first start with the bad news and then end with the good news.

On the bad news side, Q1 was pretty difficult. Spreads were tight. But as Jay said, we saw with the dividend [RMCs] and spreads and volumes pick up in Q2, and Q3, the volumes and spreads were attractive and attractive, for example, relative to a year ago. And again, we attribute that primarily to higher M&A volume, higher IPO volume, and again, whether it's durable into the future is a little bit of a crystal-ball question. But we are certainly happy with the trends we've seen over the last six months.

Great, really helpful. And then, on the FX settlements, I think I recall a few years ago when this broke you seemed fairly resolute that the cases didn't have a lot of merit. I know it's difficult to say much, given that you still have a number of cases pending, but maybe hoping you could provide some detail about why you decided it was in your best interest to settle in these specific cases. And then, maybe in terms of order of magnitude or just number of cases, how much of this might be behind us.

First of all, just to be clear, we are not announcing settlement on these cases. But these are basically situations where we are putting up reserves based upon additional information that we have. And I would not try to speculate what percentage of the overall pie this is going to relate to in terms of the indirect FX business. I think it's way too early to try to size that.

Okay, fair enough. Thanks for the clarification. And then, just a real quick technical question. Wondering how you plan to charge for negative rates, whether you determined that will appear as a credit to NII or as a fee item, or is that going to just differ across clients?

It's likely to differ by client and differ by country, so differ by jurisdiction. But I would expect at this point, speculating, that the vast bulk of that would show up as positive fees. But once again, more to come there.

Great, thanks so much.

Brennan Hawken, UBS.

Thanks for taking the question. First one on the balance sheet, so we saw a pretty nice sequential increase in deposits here. How much of that was nonoperating? And do you have any insight into what might have driven some of the growth, given how strong it was?

First of all, we expect -- we estimate that the underlying growth in our core business was about, call it, $2 billion to $3 billion of the growth in our overall deposits. And the remainder of the growth in the balance sheet was a combination of growth in excess deposits, as well as some issuance of wholesale CDs, which are an important part of our plan to comply with the LCR.

Okay. And that $2 billion to $3 billion is both US and international?

That's correct. That would be a combined number.

Okay, okay, terrific. And then, thinking about the delta in SLR, clearly balance-sheet growth was part of the drop there, sequential of 40 basis points. AOCI looked like it fell, too. Were those the two main drivers, and could you break down the 40 basis points and what were the main allocations between the big factors?

Sure, Brennan. Those are the two main pieces. The growth in the balance sheet was approximately two-thirds of the 40-basis-point decline in the SLR, and the other one-third, which, when you're referencing AOCI, that's mainly the currency translation adjustment that I mentioned earlier.

What we saw was a drop in the euro rate pretty significantly at September 30. Again, from a foreign-currency translation standpoint, that's calculated on a spot basis based on currency rates as of September 30. So it had -- the drop in the euro had a disproportionate negative impact on the value of our euro capital as it gets converted to US dollars. And that was about one-third of the 40-basis-point decline.

Great, thanks a lot.

Betsy Graseck, Morgan Stanley.

So just a couple of follow-ups. One's on the LTR. I just want to make sure I understood -- you're going to be at 80% by 1-1-2015, and then the 100% is the next year, 1-1-2016. Is that accurate?

Let me just repeat what I said earlier. We do expect to be comfortably well above the 80% at 1-1-2015. We do estimate that we would be above the 80% as of now. But we would expect to have a very comfortable margin relative to the 80% at 1-1-2015.

I just wondered, because you mentioned full compliance, I wasn't sure if that meant full compliance with the interim step or the final steps.

Again, I would characterize this as we are in full compliance of the 80% now, but I do think at the end of the day, our regulators would expect over time for us to have a significant buffer relative to the 80% and I would expect to meet that buffer at 1-1-2015.

Okay. And then on just on the European deposits and the negative interest rate that you're going to be charging, due to the fact that ECB is charging you 20 bps, can you give us a sense as to how you're talking about it with clients and others. I'm wondering, is there a way that some of your clients can avoid this potentially from going from euros to another currency, or through getting discounts for more soft dollars? Or just wanted to understand how you're positioning it.

First off, 45 days ago, we informed customers of our intent. I think the -- to me, the question will be, is this charge enough to cause people to deal with their excess deposits in a different way? We would expect that there will be some runoff of those deposits and that's probably a positive thing overall for us.

I don't think it would cause customers to change investment strategies or anything that would relate to those excess deposits. I think it's just a matter of, is the charge enough of a deterrent to keep deposits with us and therefore would they, could they, in some form move some of those deposits away from our balance sheet? But I think that's the extent of the impact.

Have you seen any activity at -- to date from when you announced you were intending to charge this? I'm wondering if people have already started to move out of euros into other currencies or you just really haven't seen much behavioral change yet?

We have not seen any behavioral change. And while we have signaled the intent, we won't start charging until later on in the quarter.

Right, right. Okay. And then just lastly on the prefs, you indicated there's another plug of prefs to do here at some point when market conditions avail themselves of you. I'm just wondering, what's your sense on that kind of timing or when you'd want to get that done? Part of me was thinking maybe you would do it by the end of 3Q that just passed for CCAR reasons, but I'd like to get a sense as to how you're thinking about it. Given the fact that term structure has come down so much, is there an opportunity here?

This is something that we are looking at. At this point, I wouldn't commit to specific timing, but I would say, just to give a high-level answer, I would certainly expect within the next 12 months that we would look for a potential window to go ahead and get a $500 million. But it will depend upon market conditions, it will depend upon our outlook. So I'd say a number of different factors to think about.

Okay, thank you.

Mike Mayo, CLSA.

Hi. (multiple speakers) pull back the lens a little bit, Jay, how do you view the market-share shifts in overall custody? On the one hand, you mentioned the strong new business growth this quarter, which is a positive; on the other hand, it looks like some smaller players in Europe have won some mandates over the past year.

Even further back, just a big-picture question, when we look at State Street's market share almost a decade ago and adjust for your acquisitions of Goldman in 2012, Intesa in 2009, and Investors Financial in 2007, it looks like your market share on a core basis, adjusting for those acquisitions, would be a little bit less than overall custody. Regardless of what you agree or disagree with, how you think about that market share would be helpful.

Sure. I can't track all the numbers that you have without doing a little math on my own. But I would say generally, we focus -- we are most concerned about market share in the most attractive markets as we view them. So if you look at, I would say, starting out broadly, asset servicing -- not asset servicing, but asset management versus asset owners, so investment management versus pension funds.

By our math, we have held, if not gained, market share over long periods of time in the asset servicing for asset managers. Pension funds, probably a little bit more stable. So that would be my first cut at it.

But then I would probably go a little deeper, Mike, and if you look at some of the faster-growing streams in the world, I would start with the alternatives hedge, private equity, real estate. Ten years ago, we were nowhere. There wasn't a market. Today, we're the market leader by quite a bit and I think our positions have continued to grow and gain share.

I'd look at another fast stream -- I'm in the US right now -- primarily ETF market, which is close to $2 trillion now. We have a pretty significant share of the ETF servicing marketplace, so, again, fast-growing market where we have established early position and have grown disproportionately with the market.

And then, I guess the third place I would go is the derivative of the asset management market. If you look at the European market where we have deep presence, our market-share leadership in both the Irish and Luxembourg offshore markets is pretty commanding and, I would say, continuing to grow.

So I look at the question and I break it down, as I always do, to say as you look in your crystal ball, which are the geographies, which are the markets, and which are the products that we think have the higher growth trajectories, and making sure -- and I think we've done a pretty good job in getting in front of those growth markets that have turned out to be pretty attractive. So that's one cut at it.

That's helpful. So just going back to the core custody business, away from those growth areas that you've emphasized, how is competition currently, compared to the past? Getting easier and you're gaining more business that way, or is it harder, or what's the rate of change?

I would say it never gets easier. But I think it's, I would say, largely unchanged.

I would say -- and it depends a lot by market. In the US, the two or three different verticals, you have mostly US competitors. We all have strengths and weaknesses. If you go to Europe, you introduce a few additional competitors.

I would say, Mike, that over the years following the financial crisis, and particularly the last couple years, pricing has seemed a little bit more stable to me. There can be a situation where somebody will throw in an irresponsible price, but I would say most of us in the servicing side of the business are being a little bit more careful about -- and thoughtful, I should say -- about how we price these opportunities.

I would also say what's helped that, and I know we have done some of this, but we are not alone, is particularly when you have an intermediary in the sales process, a consultant in particular, we have been willing to walk away from deals that didn't make economic sense. I've seen others do that as well, and I think over time that can create a little bit of a firming up or bottoming of the pricing.

So you're willing to give up market share when the pricing doesn't make sense a little more often?

Absolutely.

Thank you.

Brian Bedell, Deutsche Bank.

Most of my questions have been answered, but just a couple more to drill down a little bit deeper. Just looking at the average balance sheet, on the deposit pricing, I guess, first of all, bigger picture, what do you view as your level of excess deposits right now?

And then, in terms of the impact, if you can go into a little more granularity on charging for -- when you charge for deposits later in the quarter, how that's going to impact -- just looking at the average balance sheet, the average yield on your interest-bearing deposits down five basis points linked quarter, how you see that dynamic changing, because you mentioned there would be a fee offset, and where that would come in on fees on the P&L?

First of all, on your question on excess deposits, we estimate that our excess deposits at the end of -- I'm sorry, not at the end of the third quarter -- during the average of third quarter was approximately $48 billion. And so, we expect that in third quarter, we were earning a NIM on those assets, call it, in the high teens, down -- we've given in the past an estimated NIM on excess deposits of 20 basis points. The fact that the rates dropped in euro, the short-term interest rates dropped in euro, call it, 20 to 25 basis points over the last five months means that would push the overall NIM down to the teens level.

I would expect that there's at least the potential for the excess deposits to decline in Q4, if in fact the euro excess deposits that would be getting a negative rate go somewhere else. But that's speculative. I've probably speculated that all year and been wrong as excess deposits continue to grow, so I don't know how much confidence I'd give you in that estimate.

But as you charge for those, assuming some of those deposits stay, we should see a pickup in the net interest margin that you just outlined from the high teens (multiple speakers)

I think -- I'm not sure that's actually the case, because we are likely to pick up a partial quarter, for the most part, in maybe modestly higher fee revenue as a result of charging for deposits. So I don't think it's going to help the NIR, per se. We are earning negative interest rates on the asset side of those excess deposits, and, again, I think the negative rate credited to the client would show up in all likelihood as fees, not improved NIR.

Okay, then segueing to fees, first of all, would that show up in the core investment services fee line?

And then, secondarily, if you back out the impact, as you said, from both volumes and FX currency translation versus the second quarter, your fee growth is actually stronger, up about 2%. So just dovetailing that into some of Jay's comments earlier about some of the risk off -- I think you were saying, Jay, some of the risk off in later September, looking into fourth quarter, how should we think about that positioning in terms of your yield on those custody and administered assets?

On your first piece, again, I do think that the negative credited rates on deposits in Europe would likely show up in services. We are talking a few million dollars. This is not a big-ticket item. So I don't think it's going to hugely move the needle relative to the other factors.

And just going back to the earlier question, I would say that for the most part, the improvement that we got Q2 to Q3 in global services revenues, ex the impact of currency and ex the impact of transactions, was mainly net new business volumes. Jay wants to comment on the risk on/risk off question.

I would say picking up on my prepared remarks, Brian, there was a little bit of risk on at the beginning of the quarter and became risk off at the end of the quarter, somewhat offset by the volatility in foreign exchange or currency markets. And the equity markets have come back a little bit, so it's hard to predict at this point.

That's helpful color. Great, thanks very much.

Vivek Juneja, JPMorgan.

Quick question for you. On this incentive comp reduction that you had in the third quarter, was there a reversal of an accrual, and if so, how much?

There's not a reversal of an accrual in terms of incentive comp. What happens is that the way we accrue incentive comp, it tends to accrue based upon our overall level of earnings. I mean, there's some adjustments that go into it, plus and minus. But as a result of, again, those factors, the accrual was slightly lower. That was not a material impact in the quarter itself.

Okay. And then, secondly, your ABS came down pretty sharply in the quarter, while I guess treasuries went up. So that's the change going on, I'm presuming. And how much more do you need to do in that?

So first of all, you are right in terms of your description. We did have a major security sale in the quarter and basically reinvested the proceeds in US treasuries. That's all part of being LCR compliant.

In terms of how much more we need to do, as I mentioned during the earlier question, the overall regulatory expectations regarding the calculation of operational deposits under the LCR requirements is still not entirely clear, so I would rather not try to be pinned down to a number when it's a moving target at this point.

Okay, thanks.

Jeffrey Elliott, Autonomous Research.

You mentioned that the net interest income impact from the LCR was probably going to be a bit higher than you discussed previously. I wonder, what was this in the final rules that was different from what you've been expecting?

A number of different factors, and some of it actually relates to the underlying expectations of the calculation itself, as opposed to a change in the rules.

But as an example, we have what we view to be operational deposits from both hedge-fund clients, as well as private-equity clients, that are explicitly excluded from the regulatory definition of operational deposits. We view that as unfortunate, but those are the rules. So that would be an example of something that will push up our need to hold more HQLA than we previously thought.

And then, my second question is on the FX trading revenues. Can you give a sense of how those were distributed over the quarter? Was there a big pickup late in the quarter as volatility came back or was it kind of more even throughout?

I would say it was slightly tilted towards the back end of the quarter, followed the volatility change throughout the quarter that I mentioned. Volumes were pretty steady throughout.

I would just add the volumes have really been strong, as Jay indicated. So, again, we view that as a very positive thing, and also a positive sign that the investments that we've made in our direct FX capabilities over the last several years are really paying good dividends.

So it was strong volumes throughout, and then a kind of kick up in the volatility at the end?

Yes.

Correct.

Great, thank you very much.

Jim Mitchell, Buckingham Research.

Good morning. Just a follow-up on the preferred issuance thought process around the SLR. It seems to me that if you take your balance sheet back to where it was a year ago and assume some of these excess deposits run off as rates eventually move higher, you had, based on my back of the envelope, almost 100 basis points of the SLR, and then, all of a sudden, it's not a constraint.

So as you think about meeting that at least temporary constraint with preferred, does it make sense to wait to see how the excess deposits move? I just want to get a sense of how you're thinking about that additional preferred above the 1.5%.

First, what you're describing is rational and that is part of the overall calculus in terms of the preferred issuance. As I was mentioning to Betsy, there are number of different things to think about. One of those, of course, is what will happen to excess deposits, particularly when rates rise.

The other piece, though, that you didn't mention, and I feel compelled to mention, is remember that by the time we get to 2018 and the SLR is fully in effect, we will have lost all of the interim credit on the intangibles. And so, we estimate that's worth about 40 basis points. So you'd want to pro forma the 5.4 down to 5.0 for the loss of that credit on the intangibles, and then, as you said, you could conceivably boost it by 100 basis points if you assumed all the excess deposits found a different home.

We would probably still want to have some kind of buffer off the 6. So I wouldn't characterize prefs as being our only lever, but that would be a scenario where we might meet all the items that you mentioned and still end up with additional prefs.

That's helpful. That makes sense. And then, just maybe a follow-up on the NSFR. Have you looked at it at all and how that may impact the way you think? Is there more liquidity you need above the LCR or do you feel like the NSFR is, at least the way it's proposed so far, is pretty manageable?

As you can imagine, it's early. Since we don't have any final rules to evaluate, I think it would be a little bit early to say anything definitively.

I think based upon our interpretation of the preliminary guidance, it would require some additional HQLA. But again, I think the devil will be in the details of the final rules and I wouldn't try to speculate and try to put a number on it at this point.

Great, thanks.

Adam Beatty, Bank of America.

Good morning. Just one question from me today. In regards to your operating leverage target, I was just wondering, given where your business sits right now and where the market conditions are, would you need -- in terms of it being subject to market conditions, would you need the market to revert to more of an upward trend? Would flat from here allow you to achieve operating leverage? What's the color around there?

Also, it seems like you're somewhat confident about hitting your goal in terms of revenue growth, so to me that sort of points to expenses as maybe the risk around operating leverage. Maybe if you could just flag up the biggest risks that you see. Thanks.

It's Mike. Again, there are any number of different factors that will impact the Q4 revenue. Obviously, as we talked about earlier, we were pleased with the Q3 results, particularly the strength in our core servicing and management fees, and then the additional benefit that we got from the strong direct FX trading results, and also the securities lending business, both enhanced custody and the agency businesses.

Obviously, we are pleased with all of that. Exactly what conditions are going to be in Q4 in all those areas, it's too early to tell.

Having said that, we are at 5% year-over-year revenue growth through nine months. I certainly expect that we will, barring a catastrophe, meet the 3% to 5% overall revenue target.

But you're absolutely right. The expenses have been a headwind for 2014. Mainly the regulatory compliance costs are the main item that we had not anticipated at the beginning of the year when we were laying out our budget targets and expectations for full year. I think we actually did a pretty good job in Q3 offsetting the impact of the higher regulatory expenses by finding other savings in other area and opportunities to redeploy staff, as opposed to having it all be incremental.

But I certainly would not argue with your point that expenses have been a risk factor throughout the year relative to where we started the year.

Thanks, Mike. Appreciate it.

Gerard Cassidy, RBC.

Thank you. Good morning, guys. Mike, can you share with us -- the duration of the bond portfolio extended out slightly this quarter to 2.1 years. What is your comfort level? How far out would you consider going?

First of all, I think it's important to understand that there's been no change in our philosophy or overall approach to interest-rate risk in this quarter. You are right that the duration of the portfolio increased modestly.

But importantly, please realize as well that our central bank deposits increased significantly in the quarter as well. So we ended up, on average for the quarter, with central bank deposits of $53 billion. So when I think about the duration of the asset side of our balance sheet, I look at it as a combination of the investment portfolio with, as you said, a duration of a shade over 2, and the central bank deposits, which have a duration obviously of zero. And as part of the LCR compliance, we've had to increase our HQLA revenue significantly. We've done that through an increase in central bank deposits, but also an increase in US treasuries.

Weighted together, I don't view it as a material change relative to Q2 or Q3, and certainly there's not been a change in philosophy.

Great. And then, second, can you remind us -- you touched a little bit on, earlier in the call, that you'd benefit, obviously, from a rise in short-term rates, and if the curve flattened initially, that would be positive. If we were to get a 100-basis-point rise in rates, what kind of favorable impact to net interest revenue would that be?

I think that's a difficult one because it will depend upon a number of different factors, not the least of which is whether the excess deposits that we have, the $48 billion of excess deposits that we had in Q3, stick around or not.

We do put some sensitivities out in the 10-Q. Again, that, though, is based on static client behavior. And again, our own thinking, Gerard, is that if we did see -- certainly if we saw a 100-basis-point increase in short-term rates, we believe that the vast bulk, if not all, of the $48 billion would likely find a home somewhere else. So I think it would be difficult to try to quantify that.

I think the way -- I'll tell you how I think about it. I think about it as if we get a 25-basis-point increase in rates, particularly short-term rates, I think we will get a benefit on the asset side of the equation. Particularly the half of the portfolio that is a floating-rate portfolio, we would expect, obviously, to get the bulk of the 25-basis-point benefit on that half. On the half that's fixed investment rate, we will get that over time as the portfolio rolls over.

And with rates essentially floored in so many jurisdictions, we wouldn't expect much move in the liability side. And then, as we've talked about, the second 25 basis points, it's a little more shared between us and our clients, and then it gets different beyond that. But overall, I would characterize this as a net item, but not one I would try to quantify at this point, beyond what we put out in the Q.

Great. Thank you very much.

Stephanie, I want to thank you and thank everybody else for joining us today on the call, and we look forward to speaking with you again at the end of the fourth quarter. Thank you.

This concludes today's conference. You may now disconnect.