State Street Corporation Q4 2008 Earnings Call Transcript

Jan.20.09 | About: State Street (STT)

State Street Corporation (NYSE:STT)

Q4 2008 Earnings Call

January 20, 2009 9:30 am ET

Executives

Kelly McDonald - Senior Vice President, Investor Relations

Ronald E. Logue - Chief Executive Officer

Edward J. Resch - Chief Financial Officer

Analysts

Glenn Schorr - UBS

Kenneth Usdin - Bank of America Securities

Nancy Bush - NAB Research

Michael Mayo - Deutsche Bank Securities

Betsy Graseck - Morgan Stanley

Gerard Cassidy - RBC Capital Markets

Operator

Welcome to State Street Corporations fourth quarter conference call and webcast. (Operator Instructions) Now I would like to introduce Kelly McDonald, Senior Vice President for Investor Relations at State Street.

Kelly McDonald

Before Ron Logue, our Chairman and Chief Executive Officer, and Chief Financial Officer, Ed Resch, begin their remarks I would like to remind you that during this call we will be making forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors, including those discussed in a Form 8-K filed this morning, as well as State Street’s 2007 annual report on Form 10-K and its subsequent filings with the SEC. We encourage you to review those filings, including the sections on risk factors concerning any forward-looking statements we may make today. Any such forward-looking statements speak only as of today, January 20, 2009, and the corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

I would also like to remind you that you can find slide presentations regarding the corporations investment portfolio and asset-backed commercial paper conduits as well as our fourth quarter and fiscal year 2008 earnings press release, which includes reconciliations of non-GAAP measures referred to on this web cast, in the Form 8-K filed this morning, a copy of which can be accessed in the investor relations section of our web site as referenced in our press release this morning.

Ronald E. Logue

Good morning everybody. This past week and weekend have been very unsettling in the global markets for financial stocks. Last week two of the larger U.S. banks announced continuing issues and sought further assistance from the government, impacting investor attitudes towards U.S. financial stocks.

Then yesterday regulatory intervention in the United Kingdom further damaged the market and its impact in the U.S. today is as yet unknown.

We, today, announced strong 2008 results and fortunately have built our regulatory capital. Our tier-1 capital stands at 2.49% and our tier-1 leverage ratio stands at 7.74%. Now, despite the two strong ratios, we understand that many of our investors are concerned about the mark to market impact of conduit consolidation on our tangible comingled ratio, therefore we had considered raising additional equity capital.

To assess that issue and evaluate the current market place we held confidential discussions with some of our institutional investors. Based on these discussions, and given our strong regulatory ratios, our outlook for 2009, the strength of our business, we have determined not to raise equity capital.

As several of them mentioned, the environment right now is changing very quickly. We are likely going to see additional government initiatives to stimulate a more normal financial market and in fact, as I will explain in a minute, the marks on our investment portfolio have improved over the past two weeks.

In addition, we expect to generate between 160 basis points and 200 basis points of organic capital over the course of 2009. Obviously the increases in the negative marks in our investment portfolio and in our conduits concern us but we still believe that they are for the most part a result of the lack of liquidity in the market and not a result of their credit quality.

Although the first two weeks of this year is not a valid statistical sample, we have some room for optimism as the negative after-tax marks in the investment portfolio have improved about $400.0 million after tax while the conduit marks have remained flat compared to December 31, 2008.

So what happened since the presentation at the Merrill Lynch conference on November 11, when we indicated that our outlook for 2009 was for operating EPS to approach the low end of our 10% to 15% range, and what we meant by that was 6% to 8% increase from 2008? After my remarks, in fact I believe on the very next day, Secretary Paulsen announced that the government no longer would be purchasing troubled assets with TARP funds, which in our opinion further stressed the securities markets and reflected in further degradation in our marks.

This, followed by the issues with the auto manufacturers plus more dour news about the consumer markets, caused our assumptions about our 2009 outlook to change. Hence, we are adjusting our outlook to expect flat operating earnings per share.

We believe we’ve had a head start in rebuilding this earnings growth due to our strong financial performance in 2008. Now, in many ways we are unique with respect to our financial performance compared to many others in the financial services industry. We achieved all of our financial goals in 2008, which we will discuss in detail on an operating basis.

We never reported a quarterly loss. We generated significant positive operating leverage on an operating basis. We achieved record revenue growth. We quietly and successfully integrated our acquisition of Investors Financial while keeping almost all their customers. Throughout the last six quarters of market turmoil all the assets in our investment portfolio and conduits that were due to mature during that period, did in fact, mature at par.

As we have been saying all of our unmatured portfolio holdings continued to make required interest and principal payments.

Now regarding our 2009 outlook, we expect servicing fees to be down. New business momentum is strong going into the first quarter. Market disruption has caused many participants to rethink outsourcing of their administrative functions. We don’t think securities lending revenue is going to suffer the kind of contraction some may think.

The customers’ flight to quality is expected to become a bigger wave as time goes on and will manifest itself in later quarters and later-year revenue. This should benefit trading as there will be fewer secure firms with which to trade. Likewise, hedge funds, many of which do their own administration or source it to a prime broker, are looking to outsource administration to independent third-party providers, like State Street.

Managing expenses will be a bigger factor in our performance. Although we will keep our long-term financial goals, we do not expect to meet them this year but we are creating the foundation to allow us to meet those long-term goals in later years.

Let me briefly be a little more specific about our 2008 performance. For the year and the quarter, whether on an operating or a GAAP basis, we are into profit. On an operating basis, comparing 2008 with 2007 revenue increased 25% against our goal of 14% to 17% and EPS was up 14% against the goal of 10% to 15%. Our return on common equity, also on an operating basis, was 17.9%, ahead of our 14% to 17% goal. Given the background of the market disruption I would say our business performed very well.

Looking at the entire year, we saw a continued strength in our servicing, trading, and securities finance businesses, despite weakness in equity markets. Our servicing fee revenue was up 11% in 2008 compared to 2007 and our management fee revenue was only down 10% compared to a decline of approximately 18% on average in the S&P 5000 and the EAFE.

Due to increasing spread in securities finance and volatility in FX markets both of those businesses grew whether comparing 2008 with 2007 or comparing the quarterly year-over-year rate or the sequential quarter rate.

Fully taxed equivalent net interest revenue, due to the reduction in the Federal Funds rate as well as the impact of additional deposits left with us, increased 56% comparing 2008 with 2007. The net interest margin certainly outperformed most expectations.

And lastly, through a combination of revenue growth and cost controls, we achieved about 240 basis points of positive operating leverage for 2008 compared with 2007.

Due to the continuing questions we get on our securities lending program let me also differentiate our program for you. First, we act as agent, not as principal. Securities lending provides a vital source of liquidity to equity, bond, and money markets, as well as reduces the cost of trading and settlement thereby benefiting all market participants.

Our securities lendings funds continue to perform well despite illiquidity in fixed income markets, a dramatic deleveraging of the markets generally, and reduction in the demand of borrowed securities. The investment funds underlying the program are invested conservatively. It is true that some of our customers have suspended participation in our program but that number has not changed significantly since the end of the third quarter when we reported about 10%, or 45, of our customers had suspended participation in our program.

We have seen increased withdrawal activity from the collateral pools due to the general deleveraging in the market place but have been able to manage these outflows in a manner that protects our customers and in keeping with the flight to quality that I mentioned earlier, we are seeing additional interest in our program from several potential customers.

Continued wider spreads are expected to at least partially offset the impact of lower volumes until some of our customers resume their lending activities. If spreads narrow we would need to see an uptick in volumes to maintain the same revenue levels. So I would contend that while our securities lending industry is facing challenges, our securities lending program remains strong.

Let me remind that the two primary ratio we manage to are regulatory. One is our leverage ratio and the other is our tier-1 capital ratio. The corporation’s tier-1 [leverage] ratio is 7.74% at December 31, 2008. We have let it rise to this level to provide us with additional flexibility. The corporation’s tier-1 capital ratio as of December 31, 2008, stands at 20.49%, we believe high by any standard. We have confidence in the quality of our assets, both in the investment portfolio and in the conduits.

Now, as some evidence of our confidence in the quality of these assets, in 2008 over $8.0 billion of our structured securities in the investment portfolio paid down. All did so at par despite the fact that they were priced on average at a 7.8% discount to book value. Also, I will remind you that none are in default and all are current for principal and interest. The same could be said for the conduit marks which have improved a bit in early January and all securities are current for principal and interest.

In the fourth quarter we recorded about $78.0 million in other than temporary impairments, 0.1% of our total average portfolio, I hope you would a agree a very small number on both an absolute and a relative basis. We believe multiple government programs, like the TARP and others, anticipated by Washington will eventually have a positive impact on the overall market environment. Our unrealized marks, at least for the first two weeks of this year, have improved.

Importantly, we can earn 40 basis points to 50 basis points in organic capital each quarter in 2009. We believe our assets are for the most part going to mature at par. All our assets, both in the investment portfolio and the conduits, as I said, are current for principal and interest.

Moody’s has reviewed our assets. They consider the ultimate loss on the portfolio to likely be low on a held-to-maturity basis. Our regulatory ratios are among the highest in the financial services industry.

We are also making progress at reducing the size of our asset-backed commercial paper program, which stood at $29.0 billion as of December 31, 2007, and was about $24.0 billion as of December 31, 2008.

So if the FASB proposal is passed as it exists today, we believe we would be required to consolidate the conduits on January 1, 2010. We are managing the conduits to a smaller size, which together with at least four more quarters of additional organic capital growth and hopefully more normalized markets, will help to mitigate the impact of consolidations.

Now sometimes we are asked why don’t we just consolidate the conduits and put this issue behind us. Well, the answer is simple. Our financial risk is exactly the same, whether we consolidate or not. We still have exposure to the assets, which as we have repeatedly said, we believe the vast majority will mature at par.

Now until markets begin to repair and resume some degree of normalcy, we expect some volatility to continue in foreign exchange and spreads to remain wider than normal in securities lending, we would say at least during the first half of 2009.

There is also an emerging strong interest on the part of traditional asset managers to finally outsource the administrative functions of their business and we are talking with many of them now. Now there is no guarantee that we will see many large outsourcing deals this year but we are talking to firms that heretofore would not have entertained the idea.

And I mentioned earlier, we expect to see additional business from large hedge funds that traditionally self-administer.

On the expense side, we are executing against our reduction in force and other strategic cost initiatives that we announced in December. We are maintaining very tight controls on headcount and we are budgeting no salary increases in 2009.

At this point I would like to turn the call over to Ed to give you more detail.

Edward J. Resch

I would like to start talking about the investment portfolio, particularly the mortgage-backed and asset-backed securities classes, which in November saw a significant widening of spreads in what we think is an incredibly illiquid market.

During the quarter we made one classification change in the investment portfolio where we transferred $14.6 billion of RMBS, Alt-A, and CMBS assets to the held-to-maturity portfolio from the available-for-sale portfolio. 97% of these securities are rated single-A or above. As we have said many times, we believe these assets are high quality and we have the ability and intent to hold them to maturity.

The unrealized after-tax mark widened by $3.0 billion from $3.3 billion at September 30, 2008, to $6.3 billion at December 31, 2008. With respect to the November 7th transfer of the $14.6 billion of assets from the available-for-sale portfolio to the held-to-maturity portfolio, $1.4 billion of after-tax unrealized losses is included in equity and therefore is included in the OCI calculation.

As of last Friday, January 16, 2009, the after-tax unrealized loss in the investment portfolio had improved by $400.0 million to $5.9 billion compared to December 31, 2008.

As to the investment portfolio, the illiquidity in the market resulted in an increase in the unrealized after-tax marked to market loss in the conduit portfolio to $3.6 billion, an increase of about $1.4 billion from September 30, 2008, due primarily to higher credit spreads on U.S. non-agency RMBS.

As of last Friday, January 16, 2009, the unrealized after-tax loss on the conduits remained approximately flat compared to December 31, 2008.

Now let me move on to a discussion of our fourth quarter results. This morning all of my comments will be based on our operating basis results as defined in our press release this morning. In Ron’s remarks he highlighted some of the achievements of the year. My remarks will focus on the fourth quarter’s operating results.

Servicing and Management fees actually performed fairly well, particularly in light of the more than 40% decline on average in market valuations on both the S&P and the EAFE comparing the fourth quarter of 2008 with the fourth quarter of 2007. The continuing volatility in the market benefited our trading revenue growth, particularly foreign exchange, compared to the fourth quarter of 2007.

Performance in securities finance was also strong on a year-over-year and quarter-to-quarter basis. At quarter end we had $347.0 billion in securities on loan and the duration on the securities lending book was 22 days.

I would like to stop here and call your attention to the 8-K we recently filed, calling attention to the net asset values in the co-mingled pools of assets that support our securities lending program. These pools represent about one-third of the total $347.0 billion period end securities on loan that I just mentioned. The securities lending business transacts at one dollar while the net asset values of the underlying funds float over time.

On December 31, 2008, the average current market value of the unregistered funds was approximately $0.939. The issue that we have highlighted is whether our participants in our program, including our SSGA funds that engage in securities lending, will be able to continue under current accounting rules to value the interest in the collateral pools at the transaction price of one dollar, or at the NAV of the underlying pool.

Customers continue to enter our program knowing that the valuations can vary. We have not had any credit issues on securities in the comingled pools. This disclosure does not affect customers whose cash collateral is managed in separate accounts, which is a significant percentage of our overall book, or any of our registered money market funds.

Now for the remaining items in the income statement. The increase in processing and other fees on both a year-over-year and sequential-quarter basis was primarily due to increases in product related revenue. Of particular note, however, on the higher fees from the asset-backed commercial paper program, where fees from this program increased from $5.7 million in the third quarter to $28.5 million in the fourth quarter, due primarily to the timing of rates where asset-backed commercial paper funding rates dropped relative to the higher reset rate on the assets.

Regarding the Investors Financial acquisition, we achieved accretion of $0.06 per share for 2008, significantly ahead of our original plan at the time of the acquisition.

Regarding expenses, a 6.5% increase in fourth quarter expenses compared to the third quarter. I will comment on only two areas. First, salaries and benefits expenses declined 5% for the third quarter, due primarily to a lower level of incentive compensation.

Other expenses, however, were up more than 65% compared to the third quarter, primarily due to three items. One, securities processing costs were higher than normal while the third quarter costs were lower than normal. Two, the cost of regulatory fees and assessments increased more than $30.0 million and three, risk and compliance expenditures increased. We do not expect this level of increase on the other expense line to continue into 2009 but rather expect it to decline about 20% on an annual basis.

Due primarily to strong customer deposit flows and the lowering of the Fed Funds rate late in the third quarter and again in December, net interest revenue increased about 42% from the year-ago quarter and was up 27% from the third quarter. The 75 basis point cut was unexpected at the time of the third quarter call and so our performance exceeded our expectation at that time.

Net interest margin of 228 basis points was up 6 basis points from the third quarter of 2008 on an operating basis.

Now let me turn to the investment portfolio. The size of the investment portfolio has not changed significantly since the third quarter. However, as I mentioned in my opening remarks, the unrealized mark to market losses have widened further as of year end.

Two issues continue to dominate the financial system, declining housing valuations and weakness in consumer markets as unemployment increases. It appears as if the government’s proposed programs are beginning to impact these two issues but it is far too early to tell if the government actions will eventually return these markets to a more functional state. In our investment portfolio slide presentation we have updated the data through year end for you to review.

Since our holdings of non-agency RMBS, Alt-A, and subprime asset-backed securities have raised questions, let me provide some additional data on these compared to industry bench marks, particularly the JP Morgan MBS Credit Index for the mortgage-backed securities, and the ABX for various vintages in the [Ntex] indices.

First, the non-agency prime RMBS holding. The JP Morgan MBS Credit Index shows a loan to value of 71% and State Street’s holdings have an average loan to value of 69%. Credit enhancement, the JP Morgan MBS Credit Index has credit enhancement of 5% whereas State Street’s holdings have an average credit enhancement of 9.1%. 84% of our holdings are rated triple- or double-A and 61% are rated are 2005 vintage or older.

Then the non-agency Alt-A holdings. The JP Morgan MBS Credit Index shows 24% of these holdings comprised of option ARMs whereas State Street has no option ARMs in its portfolio at all.

Secondly, the 37% of the Alt-A securities in JP Morgan’s MBS Index are fixed rate whereas State Street has 73% fixed rate. The JP Morgan MBS Index has a loan to value of 75% in its Alt-A holdings whereas State Street’s loan to value is 69%. And the credit enhancement on the Alt-A securities in the JP Morgan MBS Credit Index is 7.5% and State Street’s is 11.1%.

And last, the subprime asset-backed securities. State Street’s credit enhancement is almost 43% and 45% of its holdings are from vintage years 2005 or earlier. The historic cumulative loss for State Street’s 2005 portfolio is 3.91%, for 2006 is 4.01%, and for 2007 is 3.53%. The [NTEX] market shows 4.95%, 8.1%, and 5.61% for respective periods and the ABX historic cumulative losses are 5.73%, 6.89%, and 5.54%, also for the respective periods.

I use these three examples to illustrate the differences among our holdings and those referenced in industry-wide tables, which I realize many of you may rely on for information. As Ron said earlier, we expect the overwhelming majority of these assets to mature without loss. We chose them after a thorough review of their quality and risk in those assets.

I think everyone will admit these are very unusual times and we believe our portfolio has and will continue to perform very well. During the quarter, we recorded $78.0 million of other than temporary impairments and for all of 2008 we reported $122.0 million, or about 0.2% of the average portfolio for the year.

At the same time, we are not in the corporate lending business. The majority of the loans on our balance sheet are customer overdrafts, mostly overnight, and are not subject to the types of credit risks associated with commercial or mortgage loans.

As of December 31, 2008, our portfolio was 89.3% rated triple- or double-A, 78.2% triple-A rated and 11.1% double-A rated. We have had no defaults and all securities are current as to principal and interest.

For the past two quarters our balance sheet has been larger than normal due to increased liquidity from our customer deposits in the recent market environment and our participation in the Fed’s AMLF facility.

I remind you that we bear no credit or capital risk for holding the AMLF assets. As we indicated on the third quarter call, we are not reporting revenue from the AMLF program as part of our operating revenue for 2008 or for 2009. Although it has been extended through April 2009 we expect it will be phased out by then. As of December 31, 2008, we left $52.0 billion in excess balances with central banks.

Ron already talked about the two main ratios that we manage to, leverage ratio which stands at 7.74% as of December 31, 2008, and the tier-1 capital ratio which is 20.49%. On a pro forma basis, considering consolidation of the conduits, as of December 31, 2008, the tier-1 leverage ratio would decline to 5.56% and the tier-1 risk based capital ratio would be 14.73%. Our TCE ratio is 4.46% but is 1.05% on a pro forma basis considering consolidation of the conduits.

Next, the discussion of the asset-backed commercial paper program. As in the past, you can find a detailed quarterly review of the assets displayed by type, country of origin, and ratings in the asset-backed commercial paper slide presentation. Also there you will find the unrealized after-tax marked to market losses for each asset type and the stresses we apply to them. In the interest of time I will not discuss them in detail today.

As of December 31, 2008, the conduits held assets of $23.9 billion, down from $25.5 billion on September 30, 2008, due to the strengthening of the U.S. dollar as well as asset amortization. As I have said many times, we created this program in 1992, primarily to address customer requests for high-quality, highly-rated commercial paper.

The conduits have never suffered a credit loss on any asset they purchased, evidence of our strong credit discipline. 78% of the assets are rated triple-, double-, and single-A, compared to an average computed by Moody’s of 51 programs, which is 30%. None of the assets in our conduits are subprime nor are there any SIVs in the conduit program. As of December 31, 2008, the assets continued to have an average weighted maturity of about four years and as I have said, all securities in the conduits are current as to principal and interest.

As I am sure you aware, the commercial paper market has been considerably strained, particularly in the fourth quarter. As a result, we utilized the CPFF program to prudently manage our year-end liquidity position. As of December 31, 2008, our conduit sold $5.7 billion in commercial paper to the CPFF program and we held just $230.0 million of commercial paper on our balance sheet.

Due to the high quality of the assets and their performance, we do not currently believe we need to consolidate the conduits. We stress test the assets to support this conclusion, and of course if the credit situation were to deteriorate more severely than the criteria we used in our testing, then we might be required to consolidate them in the future.

From a funding standpoint the risk of a more immediate consolidation is included in our continuously funding plan. Also, we are well prepared for a consolidation if required by FASB as of January 1, 2010. Also, the CPFF provides us with a liquidity facility for our commercial paper, if necessary.

As of December 31, 2008, given the market environment, we carried about $43.0 billion in liquid assets on our balance sheet.

Before I make some concluding remarks I do want to correct some misinformation in the market. In the fourth quarter of 2007 we took a charge which included $160.0 million we contributed to SSGA’s stable value funds. That infusion was made in January 2008. We took an additional charge of $450.0 million for an infusion made in the fourth quarter of 2008. The January 2008 contribution has been misinterpreted as January 2009. We have not put any money into the stable value funds during 2009. And those funds today are among the healthiest in the stable value industry.

Let me make a few brief remarks about our outlook for net interest revenue in 2009. First of all, we believe 2008 was an anomalous year with unusually strong growth in net interest revenue and atypical net interest margin expansion. In 2009 we assume that we will continue to invest conservatively, preserving capital, and not reach for yield.

We have about $15.0 billion in assets maturing in 2009. The spreads available to us for reinvestment are wider by about 100 basis points than the spreads of the assets maturing. We are evaluating opportunities for reinvestment carefully and are waiting for government programs like the TALF to take effect so as to create a more normalized environment for new issuances.

We expect the yield curve to remain steep but with LIBOR spreads coming in as the market more normalizes. We expect interest earning assets to remain relatively stable with those of 2008.

Our net interest margin is expected to be around 225 basis points, on average to the year, about flat with the net interest margin of 2008, both numbers excluding the impact of the AMLF revenue. And in 2008 also excluding the SILO adjustment to the interest revenue.

We also assume that the Bank of England will cut its overnight rate to 1% by April and hold it at that level for the rest of the year, and similarly the ECB to cut its overnight rate to 1.5% in April and hold it steady for the rest of the year. In terms of the U.S. Fed, we expect the Fed Funds rate to stay where it is, 25 basis points, for all of 2009.

So in conclusion, 2008 was a very successful year for State Street, setting record levels of operating revenue and operating earnings per share in the face of a dysfunctional market and serious issues arising in the financial services industry. While 2009 we believe will be challenging, we also feel we are positioned to perform very well and deliver returns to our shareholders.

Now I will turn the call back to Ron.

Ronald E. Logue

Given our outlook for 2009 as compared to 2008, we believe we have the revenue opportunities and the expense controls to meet our new 2009 goals. Revenue growth is expected to be fairly flat with our record level in 2008. We expect operating earnings per share to be flat from 2008 and we expect returns on common equity to be slightly below the low end of a 14% to 17% range.

So to summarize, on the revenue side we expect the momentum we achieved in 2008 with wins to be installed in 2009 to benefit us, additional revenue synergies from Investors Financial Service acquisition, strength in the first half of 2009 in trading and securities finance due to the continuing volatility in the market, some improvement in the equity market over the year so that for the year we are assuming a 1000 average for the S&P 500, net interest margin to be similar to 2008 as Ed explained in his remarks.

On the expense side we expect to retain strong control over headcount, budget for no salary increases in 2009, and in general we expect expenses to be lower in 2009.

Now it is clear 2009 is going to be difficult for all of us. Revenue and earnings are going to be harder to find. Customers will continue to seek safety and expenses are going to be very tightly controlled. We think the survivors of this financial crisis are going to be the ones that have stronger capital positions, effective risk management processes, and a legacy of strong revenue generation.

Now we will turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Glenn Schorr – UBS.

Glenn Schorr - UBS

During the quarter how much was moved into held-to-maturity and how much?

Edward J. Resch

About $14.0 billion.

Glenn Schorr - UBS

And is there additional cost? Can I add the two numbers up and come up with an over $2.0 billion additional cost? Or if it got moved or not is there an difference on the impact on TCE?

Edward J. Resch

It’s in two pieces. We brought the securities over on November 7th and at that point in time we recognized about a $1.4 billion mark to market through equity. And then since the time it’s been in held-to-maturity the market has declined another $800.0 million, so you have to add those two numbers together to give you the effect on a mark to market basis relative to those $14.0 billion of securities.

Glenn Schorr - UBS

The $1.4 billion has moved the OCI line, correct?

Edward J. Resch

That’s correct.

Glenn Schorr - UBS

The $800.0 million has not.

Edward J. Resch

That’s correct.

Glenn Schorr - UBS

So theoretically there was no additional cost of moving anything over. I’m assuming it’s subprime, RMBS, and Alt-A and things like that got moved over.

Edward J. Resch

Yes, RMBS, CMBS, and Alt-A.

Glenn Schorr - UBS

So if there is further spread widening, that will not run through the OCI.

Edward J. Resch

That will not affect OCI nor the TCE ratio, correct.

Glenn Schorr - UBS

And just talking about the TCE, I thought there was a bit of a move by the regulators. Ratings seem to have some more comfort with TCE to risk weighted assets or maybe something in between the regulatory ratio and the TCE ratio. Where does that stand?

Edward J. Resch

The rating agencies have expressed some views on that relative to State Street and I think frankly, for one of the rating agencies their thinking on the TCE ratio has moved a bit, to consider it to be more important in their evaluation of us. And the other rating agency that I’m referring to seems to have more of a focus on risk weighted assets and other metrics.

So I think there is a little bit of a difference as to approach among the two rating agencies that I am referring to and our discussions with them relative to our ratios and our earnings release continue as they normally do.

Glenn Schorr - UBS

And normally I would say customers don’t care, but how much do customers care now? In other words, if the game plan is no capital raised right now can you run with a 1% for a while?

Ronald E. Logue

In terms of customers and in terms of past experience, there has never been that I know of any discussion about that whatsoever, so, yeah, I think we can.

Now, running with that means consolidation of the conduits, which hasn’t happened.

Glenn Schorr - UBS

And then in terms of the thought process of the go-forward, we’re kind of levered to the direction of spreads. Not as levered given the move to those some things moved into held-to-mature, but we’re still levered towards incremental widening of spreads. Is there any thought process around, besides constantly monitoring the public markets, another TARP injection, a strategic buyer? Anything along those lines?

Ronald E. Logue

Obviously we are going to look at other ways to deal with TCE but I think what we have to do is first of all, obviously it’s a fluid situation. There are going to be a lot of, I would say, different government stimulus programs. I think we have to evaluate that first and obviously take a look at that and depending on what they look like, take advantage of that if we so feel that way. So obviously we’re going to be open to that.

Glenn Schorr - UBS

On the negative spread in the conduit, you mentioned the reinvestment potential. I think I remember the rules being that you couldn’t actually go up to four quarters before you actually even need to address. The negative spread at the end of this quarter is not necessarily a force on it, is that correct?

Edward J. Resch

You’re referring to the slide?

Glenn Schorr - UBS

Yes.

Edward J. Resch

That’s actually reflective of the very positive funding costs at the conduit, given what rates did in the quarter. But you’re correct in your question in that the conduits have to be, let’s call it a going concern. And it’s not a short-term test for a week or a month. The conduit can experience a contraction in its profitability and still be considered a going concern and pass the FEN 46 test.

Operator

Your next question comes from Kenneth Usdin - Bank of America Securities.

Kenneth Usdin - Bank of America Securities

On the rating agencies, where do they currently stand as far as the current capital ratios? I think you mentioned that one might be moving towards the analysis of TCE, both have both come out and reiterated their views or changed their views at all?

Edward J. Resch

No, we’ve previewed our earnings with them and we’re awaiting their feedback. They have not given us any indication as to their reaction to this earnings announcement. Obviously we have discussed with them all of our capital ratios as part of that process.

Kenneth Usdin - Bank of America Securities

Regarding other potential calls on capital, you mentioned a couple of the items that were in the 8-K but as far as right now, are there any anticipated other charges or sizeable hits that could come down the pike like we have seen in the last few quarters, either via market-related disruptions or OTTI and if anything is baked into your assumptions?

Edward J. Resch

No, we don’t have anything like that baked into our assumptions.

Ronald E. Logue

And we don’t have anything that we’ve identified either.

Kenneth Usdin - Bank of America Securities

Can you talk about on the expense side, you talk about having a lot of flexibility. We know about the severance package but can you just walk us through just the litany of the whole expense base and if you can size relative to 2008 or how much discretionary spending you really expect that could go away as we go forward?

Ronald E. Logue

You know about the salary and benefits piece with the severance, the reduction of force that’s taking place. So that’s there. That’s obviously the biggest line item. The second biggest line item is IT and I think, as you know, the way we express that is spending 20% to 25% of our operating expense every year in IT. Now obviously in 2009 we’re going to be closer to 20%, if not at 20%, or maybe even a little lower. Obviously that’s discretionary.

One of the good things in 2008, because we had such a good year, we got a lot of things done. We built capacity, so we’re in pretty good shape there. So we have some discretionary there.

The third piece would be other expenses. You can see that other expenses were up quite a bit in the fourth quarter. Again, there, doing some things where we have some discretion and actually where we have some variable expenses in using contractors as opposed to full-time programmers.

So we have built in, over the last two or three years, a little more variability in our expenses so we are able to do more than we were able to do three or four years ago.

Operator

Your next question comes from Nancy Bush – NAB Research.

Nancy Bush – NAB Research

I guess I’m grappling, as with everybody else, with the change in guidance and I realize that if indeed you come through with flat operating earnings in 2009 versus 2008 that is probably going to be a heroic performance, but why did you wait until now to lower the guidance? I mean, it’s not a news flash that 2009 was going to be a tough year, so why didn’t you do this at the end of the fourth quarter?

Ronald E. Logue

We just waited for the earnings call. There was no real reason why we didn’t do it the. I guess we could have but we were just going to do it in conjunction with our earnings.

Obviously we also needed to understand what the situation was. We had to approve a budget from our Board in the middle of December, so I would say just normal reason, no particular reason.

Nancy Bush – NAB Research

Could you repeat any specific line item factors that have led you to lower the guidance from, I think it was up 10% to 15% to flat.

Ronald E. Logue

A lot of it had to do with what happened in the last quarter of the year. Let’s talk about rates for a second. You know the Fed rate going down to 0.25%, what’s happening with rates in Europe, the markets themselves in general, in terms of our assumptions of where we thought the equity markets would be, continued dislocation. And all that was emerging and happening in the last couple of months of [2008] as we were gauging basically what we thought we could do and looking at where some of those offsets were. One, expense, and two was the other revenue lines where we could do some things.

Also understanding that there was significant new business that was sold in the third and fourth quarter that was being installed in the first and second quarters. I think we alluded to it in the press release. We may not have alluded to it here but I believe the number is $317.0 billion of custodial assets that will be installed in the first and second quarter and vary types of revenue.

So all of that was being factored in in that equation to come to that conclusion.

Nancy Bush – NAB Research

Since the improvement in the TCE ratio, which is what you’re forecasting 40 basis points to 50 basis points per quarter, is based on your comfort with your outlook for 2009, what is your comfort level with the new guidance?

Ronald E. Logue

We feel pretty comfortable about that. If things got worse, obviously that’s going to have an effect but I think, like a lot of others, we’re thinking towards the latter half of the year, hopefully things will get better with all of the government programs. We’re seeing potentially some continued big business wins. I talked about some of the outsourcing things.

Like I said, I can’t guarantee that but the activity in the pipeline and the fundamental business is extremely strong right now. I think a lot of that has to do with the flight to quality so we feel pretty comfortable in terms of the basic business. The securities lendings spreads are still wide. We’re still seeing volatility in the FX markets. So I think there are some offsets there that we feel pretty good about.

But what we’ve come back to is the fundamental strength in the underlying business.

Operator

Your next question comes from Michael Mayo - Deutsche Bank Securities.

Michael Mayo - Deutsche Bank Securities

Can you elaborate more on the decision not to raise capital? You have one of the highest regulatory ratios in the industry but you said that you have the lowest common denominator effect. In other words, one major party says they’re concerned about your capital ratios, even if it’s just one rating agency, that becomes a relevant indicator that you need to raise capital and how did you weigh that against the reaction you got from investors.

Ronald E. Logue

Obviously the regulatory ratios are very important to us but there has been continuing concern on the TCE ratio. And yeah, the rating agencies may be going back and forth or having different opinions but I think what we need to do is balance the need for different types of capital versus in terms of earnings. And what we need to do is make sure that we have good data, a good understanding of what we think we need to do and some understanding of how the environment is going to change.

So there’s not one right piece of data that I can point to but I think it’s all of that.

Michael Mayo - Deutsche Bank Securities

Can you give more detail about what the investor feedback was? Was it like 90% said don’t raise capital? Was it unanimous among the large investors?

Ronald E. Logue

No, what I can say, I think investors said, you know the financial markets are pretty crazy right now. It’s a difficult time to do something like that. There are government programs that are going to come into play pretty soon.

As I said, what has happened in the last couple of weeks, you know things have become very disruptive, so there was a feeling that it may not be the best time. And we took that to heart.

Michael Mayo - Deutsche Bank Securities

The more general question is, I’ll put words in your mouth, I’m sure you think the stock price is ridiculous relative to the fundamental value of the firm.

Ronald E. Logue

Yes.

Michael Mayo - Deutsche Bank Securities

So the question is what can you do about it? Would you consider mergers, would you consider selling off pieces of assets? What is in your control to get the stock price higher so this doesn’t become a self-fulfilling prophecy and eliminate the flight to quality benefit that you have?

Ronald E. Logue

Obviously I can’t talk about some of those things. What I can talk about, not in detail, but things that we can do to affect TCE and things that we may or may not do in terms of the new government programs. And that’s about all I can really discuss in terms of things we can do.

Michael Mayo - Deutsche Bank Securities

The issue is we don’t know what the rules are for capital, and I say that covering the industry and covering it for two decades, what are the rules for capital, and it varies bank to bank, regulator to rating agencies. Do you agree with that and have you spoken to anyone in government about that? Because we don’t know if [inaudible] equities, we don’t know if it’s tier-1, we don’t know if it’s leverage, or if it’s case-by-case. How can we analyze the industry? Why would anyone put private capital into the industry and how would you manage your business?

Ronald E. Logue

You broke up a little bit but I think I have the essence of your question. We look to the regulatory agencies as extremely important and one of the reasons is why they are what they are. And we are going to continue to do that. But we have to look at all the ratios and find some way to moderate the balance in terms of what is the right thing to do. I don’t know what more I can say about that other than it’s truly the balance that we’re trying to find there in terms of the ratios between the rating agencies and regulatory agencies.

Operator

Your next question comes from Betsy Graseck - Morgan Stanley.

Betsy Graseck - Morgan Stanley

On the various portfolios and the duration of the portfolios, could you give us the duration of the held-to-maturity portfolio as well as the held-for-sale and the conduit at this stage?

Edward J. Resch

The investment portfolio duration is 1.69 years at the end of the year. That’s in total. I don’t have the breakout on the HTM portfolio at hand. I think Kelly McDonald can get back to you with the details there. On the conduits, a quarter of a year.

Betsy Graseck - Morgan Stanley

So one quarter?

Edward J. Resch

Yes, because it’s all floating rate.

Betsy Graseck - Morgan Stanley

And the liability side?

Edward J. Resch

Of the conduits is 25 days. On average.

Betsy Graseck - Morgan Stanley

How are you thinking about the dividend? Because the dividend does reflect your long-term earnings capability but in this environment where you are triangulating between different investor needs and capital needs, how are you thinking about that going forward?

Ronald E. Logue

I guess the best way to answer it is, we’re thinking about it and obviously we’re going to be evaluating that in the first quarter. We’ll take a look at it. I don’t think we have any hard and fast decisions about that at this point in time but it’s obviously one of the things that we can use.

Operator

Your final question comes from Gerard Cassidy - RBC Capital Markets.

Gerard Cassidy - RBC Capital Markets

How much new business did you have coming into the quarter or did you lose any business, besides due to the market deterioration.

Ronald E. Logue

Again, you’re breaking up. I think you were asking how much new business did we bring in and how much did we lose?

Gerard Cassidy - RBC Capital Markets

Correct.

Ronald E. Logue

We brought a lot of new business, continued record new business. As I said, we are installing $317.0 billion in this year that we won. The fourth quarter numbers, it was about $400.0 billion in asset servicing in the fourth quarter and about $34.0 billion in asset management.

Losses were very small in asset servicing. Actually probably smaller than we have seen in past times. And a lot of the losses were basically liquidations in funds as opposed as losses to others.

And asset management, I don’t have that right now but we will get it for you.

Gerard Cassidy - RBC Capital Markets

In the third quarter you mentioned that you had a terminated [DVS] agreement with one of your customers. You took the collateral from Lehman. You set aside $200.0 million in the third quarter. Where is the value of that [DVS] today or did you add to that?

Edward J. Resch

We are carrying on our balance sheet that collateral at a value of $800.0 million. We evaluated it at year end and determined that the carrying value was appropriate so we took no additional write-downs on that, subsequent to originally putting it on our balance sheet net of that $200.0 million reserve.

Gerard Cassidy - RBC Capital Markets

Is there any time requirement [inaudible] temporary impairment lasts longer than 12 months or 18 months? Are you forced to then make it an OTCI charge even though you may not believe that it is deserved?

Edward J. Resch

No, there is no bright line test in the accounting literature. It is an area of judgment and we have what we think is a very robust process around looking at our securities for other than temporary impairment. We have a price screen and a duration screen for how long the security has been at a certain level. That then gives us a population of securities to look at on a more detailed level. We do detailed cash flows on them and the accounting requirement is that if we determine that it is probable, that all amounts due under the terms of the securities will not be collected, then we impair it. And we did so this quarter on 11 securities for a total of $78.0 million pre-tax.

Gerard Cassidy - RBC Capital Markets

In your 8-K that you filed on Friday you talked about your unregistered cash collateral pools and how you have been purchasing them and receiving them at one dollar NAV and that the average weighted net asset value was $0.955. Did that cost you any money to keep your customers at one dollar in terms of from a P&L statement, even though the value was about .955?

Edward J. Resch

No, it did not. That’s a disclosure item in the NAV calculation. It is presented as part of our financial reporting to the customers of the program and if you recall, the program that we are talking about is one where we operate as agent in the securities lending business. So there is no financial impact to us in the quarter nor do we anticipate that there will be going forward.

Operator

This concludes our question and answer session.

Ronald E. Logue

Thank you for attending this morning.

Operator

This concludes today’s conference call.

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