The Bank of New York Mellon Q2 2009 Earnings Call Transcript

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The Bank of New York Mellon Corporation (NYSE:BK)

Q2 2009 Earnings Call

July 22, 2009 8:00 am ET


Andy Clark - Investor Relations

Robert P. Kelly - Chairman of the Board, Chief Executive Officer

Thomas P. Gibbons - Chief Financial Officer, Senior Executive Vice President

Ronald P. O'Hanley - President & CEO, BNY Mellon Asset Management

Timothy F. Keaney - Chairman of Europe, Chief Global Client Management Officer

and Co-Chief Executive Officer BNY Mellon Asset Servicing

Karen B. Peetz - Chief Executive Officer, Financial Markets and Treasury Services

Arthur Certosimo - Senior Executive Vice President and Chief Executive Officer, Broker-Dealer Services and Alternative Investment Services Financial Market and Treasury Services

James P. Palermo - Co-Chief Executive Officer, BNY Mellon Asset Servicing

Vice Chairman, The Bank of New York Mellon Corporation

Richard Brueckner - Chief Executive Officer, Pershing

Brian G. Rogan - Chief Risk Officer


Brian Foran - Goldman Sachs

Betsy Graseck - Morgan Stanley

Glenn Schorr - UBS

Thomas McCrohan - Janney Montgomery Scott

Howard Chen - Credit Suisse

Ken Usdin - Banc of America Securities


Good morning, ladies and gentlemen and welcome to the second quarter 2009 earnings conference call hosted by The Bank of New York Mellon Corporation. (Operator Instructions) I will now turn the call over to Mr. Andy Clark. Mr. Clark, you may begin.

Andy Clark

Thank you, Wendy and welcome, everyone, to the review of the second quarter 2009 financial results for The Bank of New York Mellon. Before we begin, let me remind you that our remarks may include statements about future expectations, plans, and prospects which are considered forward-looking statements. The actual results may differ materially from those indicated or implied by the forward-looking statements as a result of various factors, including those identified in our 2008 10-K and other documents filed with the SEC that are available on our website,

Forward-looking statements in this call speak only as of today, July 22, 2009.

We will not update forward-looking statements to reflect facts, assumptions, circumstances or events which may have changed after they were made.

This morning’s press release provides the highlights of our results. We also have the quarterly earnings review document available on our website, which provides a quarterly view of our total company and business segments. We will be using the quarterly earnings review document to discuss our results.

This morning’s call will include comments from Bob Kelly, our Chairman and CEO, and Todd Gibbons, our Chief Financial Officer. In addition, several members of our executive management team are available to address questions about the performance of our businesses.

Now I would like to turn the call over to Bob. Bob.

Robert P. Kelly

Thanks, Andy. Good morning, everyone, and thank you for joining us this morning. EPS was $0.23, or $267 million and on an operating basis, it was $0.51 or $602 million and of course, the main reason for the delta between the 23 and the 51 was the TARP repayment which occurred during the quarter, as you all know.

The good news is fees were up 3% sequentially, which we were pleased with and then from a bigger picture standpoint, total revenue has stabilized and that is probably the biggest news item from our standpoint during the quarter versus Q1, thinking back to Q4 on a sequential basis.

In our security servicing businesses, we had a very nice sequential pick-up in fees. Asset servicing fees were up 10% from Q1 as volumes and market values picked up. Basically we benefited from the improvement in equity values, fixed income activity, and new business.

Assets under custody and assets under management were up 6% and 5% sequentially as well. [SEC] lending assets stabilized, which is frankly encouraging. The bad news is investment securities losses remain stubbornly high and net interest income declined as our balance sheet size normalized. However, I am sure Todd will talk more about it shortly -- we feel that NII is now stabilized.

On an operating expenses line, looking at that, it was down 13% year over year and up a little bit sequentially, mostly due to some unusual items in the second quarter. Staff expense were down in both periods. On a merger synergy front, we continue along as expected and continue to get our synergies as we slowly wind down our merger integration activities for the end of the year.

We are well-capitalized. We have amongst the best capital levels in our industry, both tier one and tier one common are up this quarter versus Q1 as we normalize as stripping out the impact of the TARP. I would say overall we’re first quartile of our major peers in both of those capital ratios.

Of course, we increased the quality of our capital base by raising $1.4 billion in common equity and repurchasing TARP preferred during the quarter and this has had a very nice impact on our TCE ratio as well.

We also continue to win new business and it was evident in the quarter. In asset servicing, we won $1.7 trillion in new assets under custody over the past 12 months. In corporate trust, we grew our share of U.S. market share year over year from 30% to 32%. In wealth management, we had our 14th consecutive quarter of net positive client asset flows.

So we’ve driven about $11 billion in net inflows over the past 12 months and while in asset management, we’ve moved into eighth place in institutional investors rankings of U.S. money managers for 2009, up from 10th place a year ago. U.S. retail and international institutional flows have improved versus the first quarter.

Service quality remains very strong. In May we received the highest number of number one rankings amongst our peers in global investors custody survey and we now firmly hold number one rankings amongst peers in each of the three major custody surveys globally.

Overall, our revenue trends suggest we’ve turned a corner. We expect a slow recovery in the U.S. economy and globally. In the meantime, we are going to continue to focus on delivering great client service, gaining market share in our businesses, reducing credit and market risk, and of course reducing operating expenses.

I am not going to hand it over to Todd for a more detailed review.

Thomas P. Gibbons

Thanks, Bob. As I take you through the overview of the quarter, please know for comparative purposes I will exclude from our operating results the impact of the investment securities write-down, the TARP redemption premium and the TARP dividends, and the FDIC special assessment and the tax benefit.

You will recall last quarter we told you we saw some indications that the revenue environment was at or close to the bottom and our results this quarter would seem to bear that out. Volumes in our servicing businesses improved and we benefited from new business and the quarterly increase in market values, which helped increase fee revenue. The size of our balance sheet has declined as excess client cash that sought a safe haven during the credit crisis has continued to roll off, which together with low interest rates globally has reduced net interest revenue.

Our expenses were down year over year given the success of our cost containment efforts but up modestly on a sequential basis, driven by increases in a few non-staff categories.

We decided to move Mellon United National Bank in Florida into discontinued operations since it no longer is a strategic asset. And all of our regulatory capital ratios strengthened.

With that as a backdrop, let’s get into the numbers. My comments will follow the quarterly earnings review report beginning on page three.

Our continuing EPS was $0.23 and was reduced by a total of $0.28, including $0.23 per share or $272 million due to the TARP redemption premium and preferred dividends, as well as the impact of the FDIC special assessment on depositary institutions, and $0.05 of investment write-downs in M&I, offset by the benefit of the tax settlements.

Underlying these numbers was a generally strong performance in our servicing business in a continued tough environment. Fee and other revenue was up 6% sequentially. Net interest revenue was down 10% sequentially due to the lower level of average earning interest assets, as well as the continued low-rate environment.

Operating expenses grew by 2% sequentially and was down 13% year over year. Our operating margin for the quarter was 31%.

Turning to page five of the earnings review, you can see that assets under management and assets under custody have rebounded from the first quarter and securities lending assets have stabilized.

Our long-term flows of assets under management were positive in wealth management. Long-term out-flows in asset management during the quarter primarily reflect a $14 billion out-flow due to the termination of a very low fee relationship where we earned less than 1 basis point.

Money market out-flows totaled $2 billion, which is consistent with industry trends.

Turning to page six of the earnings review, which details fee growth, security servicing fees were up 5% over the first quarter and down 18% over the year-ago quarter. Asset servicing in particular rebounded nicely, with a 10% improvement quarter to quarter, driven by the impact of new business, higher transaction volumes and market values, and securities lending seasonality.

Securities lending fees increased $7 million over the period. Client balances have stabilized though spreads are likely to contract from the seasonally high second quarter.

Over the past 12 months, we have won an incremental $1.7 trillion in new business and asset servicing, with $259 billion coming in the second quarter. During the quarter, we won 71% of new business bids and our pipeline is up 11% over the prior quarter.

Issuer services fees were up 2% sequentially, reflecting new business wins in corporate trust and depositary receipts and seasonality related to shareowner service revenue. Fees were partially offset by lower money market related fees and a lower level of corporate actions and depositary receipts.

Issuer service fees were down 16% year over year, reflecting lower DR revenue due to a decline in transaction fees and lower corporate trust fees due to lower money market related fees, and a lower level of fixed income issuances globally, partially offset by the impact of new business.

Clearing fees declined 1% over the prior quarter and 5% over the prior year, resulting from lower money market related revenue. Trading volumes declined sequentially but were up slightly compared to the second quarter of 2008.

Asset and wealth management fees were up 3% sequentially, reflecting an increase in global market values and higher performance fees, partially offset by lower fees from money market and alternative products.

As I indicated for the last several of our businesses, the absolute low level of interest rates impacted fee earnings in proprietary and non-proprietary money market funds, reducing our quarterly EPS by approximately $0.02. This lost revenue is fully reflected in the current run-rate. Once the central banks move to a more traditional base rate, we expect to recover this revenue.

Wealth management continued to benefit from business wins and market share gains, primarily in the family office platform and the Northeast wealth markets, which have generated $11 billion in net in-flows of client assets over the last 12 months.

Wealth management has had positive client flows for 14 consecutive quarters.

FX and other trading revenue decreased 23% both sequentially and year over year. The decrease from both prior periods reflects the impact from the lower valuation of credit derivatives that we use to hedge our loan portfolio and lower interest rate derivative revenues. The sequential comparison reflects a 10% increase in FX fees driven by higher volumes while FX revenue was down year over year due to lower volumes, partially offset by higher volatility.

Investment and other income is up $61 million sequentially, reflecting the write-down of an equity investment in the first quarter of 2009, as well as improved seed capital results.

Now let’s turn to NIR, which is detailed on page seven of the earnings review. Net interest revenue and related margin continued to be influenced by historically low interest rates and the return of the balance to pre-Lehman bankruptcy levels, offset somewhat by our strategy to transition central bank cash to high quality modestly longer duration assets.

Net interest revenue was lower sequentially by 10% due to a decline in average interest earning assets resulting from what we had expected to roll off of our client cash, coupled with the decline in the value and volume of interest free funds.

Net interest revenue decreased 8% year over year, principally reflecting a narrow margin due to the decline of interest rate pre-balances, offset in part by an increase in earning assets.

The net interest margin for the quarter was 1.8%. This is in a very low rate environment and we believe the margin will stabilize as a result of recent investment decisions.

Turning to page eight, you can see that our cost reduction programs and merger related synergies continue to benefit us. Operating expenses were up 2% sequentially as lower staff expense was offset by an increase in sub-custodian and clearing expenses, and a tax -- and a reserve for tax remediation. We reduced operating expenses by 13% year over year, driven primarily by an 18% decline in total staff expense resulting from lower compensations, incentive, and employee benefits.

During the quarter, we recorded a $61 million charge related to an FDIC special emergency deposit assessment for all depositary institutions. This is something we forecast on our last earnings call, thought it was a bit lower than we had projected.

Turning to page nine of the earnings review, our average balance sheet decreased to $209 billion from $220 billion. The decrease was driven by a $13 billion reduction in deposits, reflecting the continuing roll-off of excess client cash that sought a safe haven during the credit crisis. We think the deposit base is now stable. The offsetting reduction in assets was primarily a reduction in cash left at the central banks.

Also on page nine, you can see the composition of our investment securities portfolio. The unrealized net of tax loss on our securities portfolio recorded in other comprehensive income was $4.4 billion at June 30th, an improvement of approximately $100 million compared to the prior quarter. This improvement in the net of tax loss reflects the tightening of credit spreads, partially offset by higher interest rates and the impact of FAS1574.

As a result of adopting FAS1574, the unrealized pretax loss decreased by approximately $1.2 billion in the first quarter, reflecting the price the securities would sell for in a more orderly market. As the credit markets improved and became more orderly during the second quarter, the 1574 related adjustment declined to approximately $400 million at quarter end. So if we were to exclude the impact of FAS1574, the unrealized pretax loss in the securities portfolio would have improved by approximately $1 billion in the second quarter, and the fair value of the portfolio would have been about $400 million less than the current fair value.

We have again included a breakdown of instruments that are on our watchlist. These types of securities are under more credit stress and are generating a majority of the negative marks and other than temporary impairments.

In the second quarter of 2009, we reclassified the European floating rate notes to the watch list. These securities are very highly rated. As you can see, 100% are included in the triple A, double A category and well-seasoned, but given the deterioration of the European housing market and the impairment of a small number of these securities, we determined a reclassification of the watch list was appropriate.

During the quarter, housing market indicators and the broader economy continued to deteriorate. To reflect the declining value of houses, we again raised our RMBS loss severity assumptions, decreasing the amount we expect to receive to cover the value of he original loans. These adjustments to our assumptions increased projected defaults, generating approximately $256 million of pretax OTTI.

Our regulatory capital ratios remain strong. Tier one of 12.5% compares to 11.2% in the first quarter, if you exclude TARP, and tier one common was 11.1% compared to 10%.

TCE strengthened to 4.8% from 4.2%.

Turning to our loan portfolio, we had $1.9 billion less in average loans at quarter end, a 5% decrease from the previous quarter. The provision for credit losses of $61 million was flat sequentially. [inaudible] of $54 million were less than the provision.

As previously noted, in the second quarter we adopted discontinued operations accounting for Mellon United National Bank located in Miami. It was determined that this business no longer fits our strategic focus on asset management and security servicing. This business was formally included in the other segment and during the second quarter generated approximately $17 million in revenue, principally all of it in net interest revenue.

We recorded an after-tax loss in discontinued operations of $91 million, primarily related to the write-down of good will, and an increase in the provision for credit losses. The after-tax loss of $41 million in the first quarter primarily resulted from a good will impairment charge.

Given this accounting change, the income statements for all periods have been restated. The restatement resulted in a reduction to previously reported levels of net interest revenue and the net interest margin, a slight reduction in both treasury services and other fee revenue, a reduction in the provision for credit losses, a reduction in non-interest expense and a changing our continuing earnings per share.

The effective tax rate in the second quarter of 2009 was 2.2%. During the quarter, we recognized $134 million of tax benefits, primarily attributable to the LILO/SILO tax settlement agreement in an amount less than reported. Excluding the impact of the tax benefit non-operating item, the effective tax rate was 32.4%.

On the integration front on page 12, year-to-date we have achieved $211 million in annualized revenue synergies, just below the low-end of the range for our full-year target. We realized $186 million in expense synergies during the quarter, an incremental increase of $13 million from the first quarter, and we are now 88% of the way for M&I charges.

Looking ahead, we are mindful that we appear to be in for a slower recovery than with past recessions. However, our model is leveraged to improvements in the equity and credit markets and higher rates, so we will benefit as conditions improve.

Traditionally, third quarter earnings are negatively impacted by seasonality associated with lower levels of capital markets related revenues, particularly securities lending and foreign exchange. We expect net interest revenue to remain at current low levels because of the global rate environment. However, we continue to see some positive indicators for our business model.

For the first time in many months, new issuances have exceeded cancellations in our DR business. The equity markets continue to grind upwards. Global payment activity has picked up. [Health] programs are gaining momentum and credit spreads continue to tighten, a real positive for our portfolio valuations and also a good signal for our corporate trust activity.

We are going to stay focused on managing our cost carefully, reducing credit and market risk, and continuing to deliver the exceptional level of client service that leads to market share gains.

With that, I will turn it back to Bob.

Robert P. Kelly

Thanks, Todd. Gerald and I have the entire management team here in the room and we’d be happy to answer any questions you might have, so let’s open it up.

Question-and-Answer Session


(Operator Instructions) Our first question is from Brian Foran.

Brian Foran - Goldman Sachs

Can you talk about the asset management business maybe a little bit longer term? And I guess there’s two things -- you know, one, the performance, I realize it’s been a crummy environment since the merger but the performance seems to have lagged a little bit relative to the industry and then two, you are always kind of linked to the big deals in the industry but the deals you have actually executed have been fairly small tuck-in deals, so is there anything operationally the needs to change to improve the organic performance? And then what are the kind of non-organic or related ambitions for the asset management business?

Ronald P. O'Hanley

Why don’t I take that -- in terms of the performance of the business, the asset management business revenues were up about 10% quarter over quarter, expenses up to for a pretty significant increase in pretax. To your point on performance, let’s start with investment performance. 2007 -- 2006 and 2007 were years in which our performance had peaked in 2006 in general and started to decline. 2007 was a difficult year. We actually started to see strengthening in that, and that is starting to show up in our flows this year.

We had positive long-term flows outside the U.S. and in our retail intermediary business, which is a big -- the Dreyfus business, which is a big turnaround for us, so we actually feel pretty good about where it’s positioned.

On the financial performance side, we’ve taken a long hard look at the business model and while we are committed to the multi-boutique model because we think that’s a better way to deliver investment performance, we also see opportunities to improve that. Headcount is down about 11% since the fourth quarter, yet we still continue to have the same number of investment people focused on our core product, so there’s probably more to that there in terms of how do we think about utilities across the businesses and a little bit more sharing. But right now we feel pretty good about it.

Where we have struggled is alternatives, our alternative performance is not where we’d like it to be. Much of it is very tied to quantitative products. We’re seeing again a nice reversal in that but that’s something that we would like to see more performance improvement.

Robert P. Kelly

What I would add to that, Brian, is I think we are always going to be linked to asset management deals that are occurring in the industry, just because we are big in the business and of course, we are a relatively healthy financial institution.

The fact is we do look at just about everything just to scan it and to get a sense as to any learnings from that. Historically, if you think about Ron and I working together over the last three plus years, we’ve only done two transactions. They are relatively small, Walter Scott in Scotland, which has turned out to be a fantastic deal, and the [performers] have been excellent as well as ARX in Brazil, which has been a very, very nice story as well.

When Ron and John Little and others think through their strategic options, and we talked about strategies in all our businesses in a pretty frank way, I think they have got a good model going forward and good strategies going forward. There are some changes being made to the business model and everyone should be looking at that in this environment. And it’s -- we wouldn’t exclude acquisitions in this space, that and asset services and corporate trust are spaces where over time we would look at not just organic growth, which is most of our growth levers, but also acquisitions. But frankly, we’re going to be pretty tough financially.

We would demand a very high IRR. We would demand that frankly we would do it for equity, because I don’t want to see our equity ratios decline, our capital ratios -- certainly until we have some solid evidence that the economy has turned and we want it to be accretive pretty darn quick.

So those are pretty tough hurdles, both strategically as well as financially. So I want to assure you that we are going to be very disciplined and look for longer term growth opportunities, mostly which will be organic, quite frankly.

Brian Foran - Goldman Sachs

I appreciate it.


Thank you. Our next question is from Betsy Graseck. You may ask your question and please state your company name.

Betsy Graseck - Morgan Stanley

Thanks. Morgan Stanley. Bob, when you think about the mix of the businesses that you have and the SKU that you have towards bonds and equities, could you give us a sense as to where you see it right now in terms of contribution to your top line and where you want to take that?

Robert P. Kelly

I don’t really think about it that way generally. I think about the mix of businesses and how they look versus their peers. I kind of like where we are right now. At the margin, I would like our mix to be a little more focused towards asset management and wealth, generally. But we’ve really benefited in this environment and our asset servicing businesses just because of the flows that we picked up last year and the flight to quality we’ve picked up in the last year.

I frankly don’t see an environment going forward where you are going to expect big double-digit growth in equity values, if that’s what you are kind of leading towards. There are a few geographies that we want to be stronger in, in asset management and asset servicing in Europe and to a lesser extent, organically in Asia and Ron’s been working, for example, hard on getting approvals to start up our joint venture in China, which we hope -- which we’ll hear more about very shortly and I think our mix is okay.

Betsy Graseck - Morgan Stanley

Just a question due to the fact that people kind of view equities at a higher growth asset class than bonds, and so --

Robert P. Kelly


Betsy Graseck - Morgan Stanley

But you are saying you are more skewed towards increasing your geography -- diversifying your geography mix.

Robert P. Kelly

Yeah, and at the margin, it will probably be equities where it happens and Ron, how would you answer that?

Ronald P. O'Hanley

The one thing I would add is that particularly over the last 18 months, I think the skew towards fixed income really reflected the flight to quality, so in a more normalized environment, as our cash balances go down and you see just a higher and higher demand for equity investing, I think you would see it return back to the 2006, 2007 levels

Robert P. Kelly

Tim, any -- I was just wondering if Tim had anything to add to that, Betsy, just a sec.

Timothy F. Keaney

As you know very well, the mix on a custody and asset servicing side is an important component here where we clearly earn more in equity, in global equity in particular, funds and one of the things that’s encouraging to Jim Palermo and I is as our financial institutions business, so our mutual fund, our ETF and asset management businesses grow, it tends to be more equity oriented and I think we are starting to see that in our running rate.

Betsy Graseck - Morgan Stanley

Okay, that’s very helpful. And then just a follow-up on capital -- obviously you highlighted extremely strong capital ratios. Where do you go from here with regard to capital management? What’s the new normal? And could you give us a sense of how you would be looking to use your excess capital, be it either acquisitions, dividends, or repurchase?

Robert P. Kelly

You know, Betsy, that’s a good question -- Todd and I debated, we did with the team as well -- I would say it’s firstly all about comparative numbers vis-à-vis our peers. We like being first quartile on the tier one and tier one common. From a TCE basis, if you look at us versus our larger peer group, we are kind of in the middle of the pack and given our mix of businesses and given the composition of our balance sheet, which is lower risk on average, I would say we want to be around median from a capital standpoint. Frankly it’s too early in the cycle yet to talk about dividend increases or stock buy-backs. We’re not going to do that until we see continued improvement in the economy, as well as the securities markets.

We are not constraining people really from a capital standpoint, from an organic standpoint at this point and from an acquisition standpoint, we are being very, very tough, quite frankly, on a -- from a capital standpoint on acquisitions.

Again, very high IRRs -- again, got to be accretive fast, and frankly we don’t want to see our capital ratios deteriorate because of any inorganic activity, so we think of them as being all equity deals, which is a tougher hurdle yet again.

Betsy Graseck - Morgan Stanley

Since your ROEs were going to be a little bit lower with higher levels of capital, have you adjusted for that in your acquisition analysis?

Robert P. Kelly

Yes. We are looking for businesses that tend to be higher growth than the rest of the company and tend not to be capital intensive, of course. And that’s something we are very focused on and we are more interested in businesses that have higher growth opportunities on top line versus expense take-outs, quite frankly. They are less interesting to us.

Betsy Graseck - Morgan Stanley

Okay, that’s very helpful. Thank you.

Robert P. Kelly

Thank you. And at the margin, I would just say, Betsy, if you’re still on that --

Betsy Graseck - Morgan Stanley

I’m here.

Robert P. Kelly

At the margin, we tend to look -- at the margin, we have a greater preference for outside of the U.S. versus domestically here.

Betsy Graseck - Morgan Stanley

Okay, thanks a lot, Bob. That’s helpful.


Thank you. Our next question is from Glenn Schorr. You may ask your question and please state your company name.

Glenn Schorr - UBS

Quick questions on the securities portfolio -- so if you look quarter to quarter, most of the marks are in the flattish range. I think that the stuff like credit cards, that deserves to be marked up a lot but I guess there’s a lot of underlying trends. Like some parts of the prime market got better but your all-in marks were reasonably unchanged across Alt-A, commercial, prime, and everything. So I guess the question is with unrealized loss not improving that much sequentially, with marks flattish overall but you still have high securities losses -- how do I digest all of that and not think that we wouldn’t have these ongoing headwinds in the securities portfolio?

Thomas P. Gibbons

I’ll take that. In the first quarter, we adopted 1574 which was another adjustment to fair value accounting for securities. In doing that, basically what we did is we adjusted the marks to reflect where we estimated, even though it’s in an active market, if the securities traded in an orderly market, reflecting kind of high discount rates of the inactive market, where would they trade rather than at kind of distressed level, which is where the market has begun to -- the only trades have been taking place.

By doing that, the securities that you alluded to, the primes and the Alt-As saw quite a bit of a benefit. In the second quarter, we actually saw the market become more orderly and there was a convergence between the two, so the adjustment that we made was significantly less. Had we not made that adjustment, the quarter to quarter change would have been about $1 billion pretax more to the positive.

So I think we are seeing a much healthier market and that has continued into the beginning here for the third quarter, especially a healthier market for some of the more stressed securities.

So I think it was a little bit masked in the adoption of 157 here.

Glenn Schorr - UBS

Okay, that’s definitely helpful. Where are, in terms of the securities losses actually taken, what asset classes do those come from? Is that more a commercial phenomena right now?

Thomas P. Gibbons

The CMVS portfolio, we have a relatively small CMVS portfolio, it continues to do very well and as we’ve stressed it, we don’t really see any issues in that portfolio. Where we will see issues is going to continue to be on the RMBS side and if there’s further deterioration then there is potential for more impairments and we are seeing it even in some of the prime securities where the subordination is a little bit thinner.

Robert P. Kelly

You know what I would add to that, Glenn, is when I thought about the -- I think bigger picture beyond the portfolio, we are still in an economy that is still declining so until the housing prices bottom out and unemployment peaks, we are probably still going to have some losses in RMVSs and I was mildly encouraged by the last case [Schuler] data. When you look at the 20-city data, eight of the 20 cities actually improved a little bit versus the prior quarter, which was nice to see. But we still have a ways to go yet, so we’ve got to be realistic about these portfolios until we see some fundamental underlying change in the economy in the U.S.

Glenn Schorr - UBS

I hear you. I appreciate that. Look, I think a lot of people -- I think Chairman Bernanke reiterated yesterday, low rates, expect them to stick around for a while. We’ve got some healing to do to your point on the economy and we’ve got to wait and make sure that the stimulus kicks in. So you are out buying two- to four-year paper. I read the comment, it says basically mostly government agency and guaranteed paper in the two- to four-year range, so I just -- I didn’t know if we could get anymore color on that in terms of what you are buying. And then I guess the converse is what happens when rates rise? Does that put you in a too asset sensitive position where you can see a little bit of margin pressure in the future? I’m just curious on how you all think about that.

Thomas P. Gibbons

It’s a good question, Glenn. Everything that we are buying is of extremely high grade. It’s either treasuries, treasury guaranteed, or agencies. A significant component of this is straight [bullets], so it’s two years, 2.5, three year maturities. We don’t really care to have a whole lot of extension risk with interest rates at the current level so where we’ve gone in and bought agencies, we bought what we could find in more seasoned paper that was shorter term fix, so it has a relatively short life and we’ve tested it real hard so that even if interest rates were to go up quite a bit, it doesn’t add a whole lot to the duration.

So when you look at our expected average life as well as the duration, they are not too far apart on the securities that we are buying and it’s not -- even with the extension risk, we don’t go asset sensitive with a significant increase in interest rates.

Robert P. Kelly

We would like an increase in short-term rates. That would be very helpful to us.

Glenn Schorr - UBS

Don’t we all, don’t we all -- okay --

Robert P. Kelly

We all look forward to that day.

Glenn Schorr - UBS

Last one on a --

Thomas P. Gibbons

Glenn, if I could add something -- we’re sacrificing a little bit in current income to do that, obviously.

Glenn Schorr - UBS


Robert P. Kelly

We don’t think we should be paid for taking duration risk and additional credit risk and you should pay us for our prudent management of the balance sheet and for growth in fee income.

Glenn Schorr - UBS

Amen to that -- last one, on a positive note; in the first comments, you mentioned gaining market share. Can we get a little more color on there because it’s obviously difficult to see on a quarter by quarter basis? Was that a comment on the pipeline?

Robert P. Kelly

Why don’t I ask a couple of our business leaders -- Karen, do you want to start?

Karen B. Peetz

Sure. As Bob mentioned, Glenn, we did increase in global corporate trust. We increased from 30% to 32% in the U.S. market and we are also up a little bit on the DR side, where we are up to 64% from a 63% share year-on-year. And then we are flat but still significant in shareowner services at 32%, so very good market share.

And Art has a couple of increases as well.

Arthur Certosimo

Yeah, I think in the corporate dealer services side, we’ve seen significant increase in government clearance, as well as we’ve maintained very nice market share in the alternative investment services hedge funds business.

Robert P. Kelly

They’ve executed very well in this environment. Tim, anything to add?

Timothy F. Keaney

We had a really terrific second quarter in terms of net new business wins. You heard Bob mention the $259 billion. We converted 370 and I think you are seeing that in the trust fee line.

But I just want to share some names with you that I think are pretty impressive, along with the 71% win rate, we won Credit Suisse asset management, Irish ETFs, Korea Life Insurance, Christian Brothers Investment Services, Nomura, Advisor Shares ETFs, Schaeffer Cowen Capital Management, Impression Investment Advisors. What you haven’t seen is we’ve also won nine significant non-public wins, so Jim and I feel like we’ve got some pretty good momentum rolling into the third and fourth quarter.

Ronald P. O'Hanley

You mentioned the rise in the lead table from 10 to 8. We’re seeing similar rises in Europe and Asia in terms of our share but I think probably the most gratifying thing for us is looking forward, the pipelines have strengthened a lot, particularly outside the U.S. Asia is an extraordinarily large pipeline, [perhaps the largest it’s ever been] so we feel pretty good.

Glenn Schorr - UBS

All right. Thank you all for all the answers.


Thank you. Our next question is from Thomas McCrohan. You may ask your question and please state your company name.

Thomas McCrohan - Janney Montgomery Scott

Just to follow-up on the pipeline, you sound pretty optimistic and I think you mentioned it was up 11%. Can you give us any details on the composition of the assets in the pipeline in terms of U.S. versus non-U.S.?

James P. Palermo

Clearly we are seeing a lot more activity outside the U.S. Our asset servicing pipeline is up about 11% versus the previous quarter and basically over a level that we were at even a year ago, which we are really encouraged by, as Tim said.

The bigger series that we are seeing are in Europe and in Asia and in particular, we’re seeing a lot of activity around the outsourcing world and as a result of the continued pressure that asset managers and insurance companies see in their own business models, and they are taking a look at organizations such as us to be able to take care of some of the activities that they had historically done in-house.

Robert P. Kelly

You know, Tom, it’s interesting -- a couple of weeks ago I had a look at their new front-end process, their new front-end web-based workbench product to manage the client relationships. It’s really impressive. We’re probably the only company out there that offers a single fully-integrated web-based tool to completely managing your asset servicing business and it’s awesome, quite frankly. And I don’t think there’s anyone out there who can match it and it really works well from a sales and a client relationship standpoint and there’s no training manuals. You can be up and running and enjoying the sophisticated capabilities of our teams here within an hour-and-a-half, quite frankly.

Thomas McCrohan - Janney Montgomery Scott

That’s great. And just to drill down a little bit on asset servicing, we seem to have a pretty good sequential increase in revenues. Can you talk about that business line in terms of prime brokerage services? You know, it seems like your Pershing subsidiary has been benefiting a little bit from some of the market turmoil. I’m wondering if that was included in the asset servicing and if you can just kind of maybe quantify in terms of revenues how big the prime brokerage operation through Pershing is.

Robert P. Kelly

Rich, what would you say?

Richard Brueckner

We started basically at zero last year and had a spurt of growth in the third and fourth quarter through the disruptive period as there was the flight to quality. That went on I guess a bit into the first quarter and it slowed a little bit now as things are returning a little bit more towards normal and it’s still a very small part of Pershing’s business but still growing.

Thomas P. Gibbons

Tom, just to clarify, Pershing’s revenues don’t show up in asset servicing, they show up in clearing and we aggregate them into something we call securities, overall security services.

Thomas McCrohan - Janney Montgomery Scott

Thank you, Todd. I was wondering if the prime brokerage part of Pershing was also included in the clearing. It sounds like it is.

Thomas P. Gibbons

It is, yes.

Thomas McCrohan - Janney Montgomery Scott

Great. And just one last question and then I’ll jump off -- there has been this push I guess by the Federal Reserve to create this new entity to act as a central counter-party for the tri-party repo market. I’m just trying to get my arms around that. I know it’s still in the early stages of discussion but can you kind of frame out how we should be thinking about this in terms of how it impacts your model going forward, if in fact it will be a new entity created?

Arthur Certosimo

You’re right -- it’s early stages and there’s early discussions but we think that whether there’s significant change or change all the way to utility, we are most likely going to be significantly involved in the answer, so we think from an overall impact it will probably be relatively minor.

Thomas McCrohan - Janney Montgomery Scott

Do you believe that there is a need for one or what’s your view on the necessity for a new entity?

Arthur Certosimo

We don’t think there’s a need for one. We think that with enhancements to the risk management process within the industry, we absolutely can address the federal reserve bank’s concerns and we’ve been working closely with them on a variety of suggestions that can be implemented relatively shortly to enhance the market. If we go all the way towards a utility, you have a long-term, very expensive project that is not quite clear what comes out the other side.

So we think we are in good shape by tweaking the present process.

Robert P. Kelly

You know, there was a -- you are probably thinking about the article you saw in, I forget, FT or somewhere recently and none of us really know where that came from, including from people in Washington. So this is a very important market. I think we serve it well and I think there can be some nice improvements done at the margin to improve the risk profile of the business for the nation and those things will get done and we are working very hard on it with our regulators.

Arthur Certosimo

We’re confident we’ll be part of the solution.

Thomas McCrohan - Janney Montgomery Scott

Thanks, guys.


Thank you. Howard Chen, you may ask your question and please state your company name.

Howard Chen - Credit Suisse

Thanks for taking my questions. I guess on the first one, on the broader environment, you reiterated your expectation that you think 1Q represented a near-term trough for revenues. I guess what’s broadly driving that in your expectations? I think just putting together some of the pieces of your commentary, it seems like you’ve seen net interest margin stabilizing, balance sheet potentially shrinking a bit, seasonal weakness into the summer. So I just wanted to get a sense of some of the offsets to all that. Thanks.

Thomas P. Gibbons

Sure, Howard. Starting on the net interest side, and that was pretty impactful. We had the big run-up in rates and deposits in the fourth quarter and we saw that come down. And if you look at the first three months of the first quarter, the trend line was very negative. We were able to stop that by investing in some of the assets that we just talked about and we think -- and we’ve also seen the balance sheet itself come back to what we think is pretty normal with the business and now its growth will grow as we increase our asset servicing businesses.

We are not going to see a significant increase in the net interest margin at these low rates. There is no way to do that without taking an enormous amount of risk and we are simply not going to do that.

I would say that would be the primary reflection on the net interest income.

On the foreign exchange and other trading activities, we were benefiting from very high volatility, very high volumes. Volumes have normalized, volatility has normalized but we don’t see a significant change from where we are currently -- what we are currently experiencing, except for maybe some seasonality associated with that.

On the securities lending, I think the story is the same thing. We actually saw a modest increase in average loans outstanding in the second quarter, after a very significant decline over the past year and I think we are seeing that stabilize.

We would expect spreads as they do normally in the third quarter to narrow a little bit there and I think one of the other drivers for all of our business is just a little bit stronger equity market, so our asset management, our wealth management and our asset servicing businesses are benefiting from that as well.

Howard Chen - Credit Suisse

That’s really helpful. Thanks, Todd. And then a follow-up, a specific question on asset management, and apologies if I missed this, I see the one-time termination of the low fee revenues but just curious why the institutional revenues fell 3% quarter on quarter. Is that -- I just wanted to get some color there.

Ronald P. O'Hanley

The institutional revenues is primarily a function of our alternatives, which have been weak. They have started to stabilize and even strengthen in pockets but there’s been some asset run-off there so a little bit of indexing too, but in terms of revenue, the weakness has been in alternatives. That’s been offset by continued ongoing strength in non-U.S. and a nice pick-up in our long-term flows in the Dreyfus retail operations.

Howard Chen - Credit Suisse

Okay, great and then finally on my end, just following up on capital management, Bob, I heard your commentary on desire to look at less capital intensive businesses, you know, maybe potentially deals with less in the way of expense take out going forward. But just hoping you can transpose those thoughts into relative appetites that do either something on the asset surfacing side or on the asset management side of the franchise? Thanks.

Robert P. Kelly

I would say we’re not in a rush. We are delighted with our capital ratios now and certainly compared to three or six months ago, we’re focused mainly on organic growth and great client service and winning market share.

We certainly have seen a pick-up in the U.S. of asset management opportunities. They are not real high on our priority list, quite frankly. Most of them, for the reasons that I state before, because our capabilities are quite strong here in the U.S. and on asset management and asset servicing outside of the U.S., we are seeing mild, mild, modest improvement in the opportunities but we are going to be very tough and disciplined and focused. And frankly, you know, we are the biggest in the world at this business and it has to be something kind of unique to really be of interest to us and then it has to be financially more or less a home run.

Howard Chen - Credit Suisse

Great. Thanks.

Andy Clark

Wendy, I believe we have time for one more question.


Thank you. Our final question is from Ken Usdin.

Ken Usdin - Banc of America Securities

Good morning. Just two quick ones -- first of all, Todd, with your comments about just the foreign exchange business, this quarter it seemed like the core FX looked like it was up but the decline was really more to the derivative side, so can you talk about is that one-time or is that seasonal? And so when you think about going forward, does that -- overall, does that business come down off of the second quarter number or does some of that write-down on the derivative side kind of go away and you just kind of build off of the core FX?

Thomas P. Gibbons

Sure, Ken. There are really two components -- the core FX was, like I said, was up 10% sequentially and it’s actually doing quite well, just a reflection of the rest of our businesses as we continue to capture the opportunities within the institution.

There are really two drivers of the weakness in the other trading. One was we have a portfolio of credit derivatives that we use to hedge what we call our tall trees and our credit risk. Those credit derivatives showed modest gains quarter after quarter as we saw widening in credit spreads and that’s a mark-to-market. Unfortunately, it’s a geography issue with -- for the accounting treatment but it is mark-to-market through the P&L.

In the second quarter, we saw a very significant tightening of credit spreads which was reflected in that derivative portfolio, so on a quarter over quarter basis, that was a very large decline in our trading revenues.

We did harvest some of those gains during the quarter. We would not expect to see that kind of volatility in the hedging portfolio.

The other component was primarily related to our interest rate derivatives where we had a strong first quarter and we had a weaker second quarter and that business is a little more episodic. It will have a little more volatility. It’s not seasonal. It’s just driven by client activity.

Ken Usdin - Banc of America Securities

Okay, and that leads actually to my second question, which is it seems like embedded within the income statement, there’s always a lot of offsetting factors right, so better markets help but then lower volatility actually technically hurts, as some of the volatility in volume businesses go away. So I guess what do we need to look forward to to get everything kind of moving in the same direction again? Meaning does that revenue diversification impact the amount of revenue upside we’ll see going forward? Or do we get to the point where higher market levels actually bring volumes and volatility back up in a healthy way? So I’m just trying to understand directionality of the business lines and when some of those offsets can start moving the right way.

Thomas P. Gibbons

I think generally, Ken, the key thing is we are leveraged to the capital markets. There’s no question about it. To the equity markets, to transaction volumes, to volatilities, to cross-border payments, to global economic activity -- that’s what we are highly linked to.

This extremely unusual interest rate environment is a bit of a negative and we get some one-time benefit from volatility but it also typically is a reflection of something that can cost us too, so I -- kind of this high octane earning that we got at NII and SEC lending and even the FX, I think we had pretty much indicated to you that we thought it was relatively short-term in nature, it was kind of a 2008 phenomenon. So I’d go back to the 2006 and 7 run-rates for those types of activities to see what it might look like normalized but we are going to -- we are going to be linked to the capital markets.

Ken Usdin - Banc of America Securities

Okay, and -- yeah, that answers my question well, thank you. And then the last thing, you mentioned the improvement in spreads affecting the corporate CDS, can you talk just a little bit more color on the core loan book portfolio? It looks like the over provision was narrower this quarter and NPAs, if you kind of normalize for the discontinued ops, were kind of -- were pretty good.

So what are you guys seeing as far as corporate credit deterioration and how confident are you that this is kind of -- kind of the right level for the provision going forward?

Robert P. Kelly

We’ll have Brian, our Chief Risk Officer, just kind of talk to that for a second. You thought you were going to get away with not having to talk but go ahead.

Brian G. Rogan

Such is life -- to comment, the CDS book, we view that as a risk mitigant and not a trading book, and as Bob mentioned before, we are going to be dogmatic about reducing the risk of our balance sheet, so we don’t get hedge accounting but we view that as a risk mitigator so that will be there.

On the general portfolio, I think you traditionally in this point of a credit cycle because of the regulatory exams, we’ll see an up-tick in NPAs in the third quarter, and provisioning -- we don’t think it will be material, so we’re pretty confident that this kind of level with that one up-tick through 2009 and we’re hopeful that as we get into 2010, the economy turns so that we can see those levels back off.

Robert P. Kelly

You know, what I would add to that is we’re in the business of -- you know, we’re a different business. We don’t take principal risk, so we don’t have the big trading profits. This is about the equity markets and flows and us benefiting from that from a -- from that standpoint. We have been working very hard for two years to integrate our two companies, get the expense synergies and get the revenue synergies into our financials. We’re also working really hard to change the fundamental nature of our balance sheet to take risks out and take those one-time things away from you in the future. We’re going to continue cleaning up this balance sheet and we’ll get it behind us and it will be fundamentally we’re building an awesome company for the future and as when the economy comes back, so will we.

You know, it feels like and we are hopeful that we have stabilized the revenue picture and perhaps we have turned a bit of a corner from that perspective and in the meantime, we’re going to focus on the basics, just delivering great client service and keep working on building market share because I think we have a superior model than most, and we’ll keep working on the balance sheet from a credit and market standpoint and reducing our operating expenses. And I want to thank you for being on the call and I just want to remind everyone that Andy and the team are available for any questions you might have. Thanks for doing this and have a great day.


Thank you. If there are any additional questions or comments, you may contact Mr. Andy Clark at 212-635-1578. Thank you, ladies and gentlemen. This concludes today’s conference call. Thank you for participating.

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