State Street Corporation Q3 2009 Earnings Call Transcript

Oct.20.09 | About: State Street (STT)

State Street Corporation (NYSE:STT)

Q3 2009 Earnings Call

October 20, 2009 09:30 AM ET

Executives

Kelley MacDonald - Senior Vice President, Investor Relations

Ronald Logue - Chairman, Chief Executive Officer

Edward Resch - Chief Financial Officer

Analysts

Glenn Schorr - UBS

Howard Chen - Credit Suisse

Michael Mayo - CLSA

Betsy Graseck - Morgan Stanley

Marty Mosby - FTN equity capital

Gerard Cassidy - RBC

Vivek Juneja - J.P Morgan.

Brian Bedell - ISI

John Stilmar - SunTrust

Operator

Welcome to State Street Corporation’s Third Quarter Call and Webcast. Today’s discussion is being broadcast live on State Street’s website at www.statestreet.com/stockholder. This call is also being recorded for replay. State Street’s call is copyrighted. All rights are reserved. (Operator Instructions). Now I would like to introduce Kelly McDonald, Senior Vice President for Investor Relations at State Street.

Kelly McDonald

Before Ronald Logue, our Chairman and CEO and CFO, Edward 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 important factors including those discussed in State Street’s 2008 Annual Report on Form 10- K and its subsequent filings with the SEC including its current report on Form 8- K dated May 18, 2009.

We encourage you to review those filings including the sections on Risk Factors concerning any forward- looking statements we make today. Any such forward- looking statements speak only as of today, October 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 a slide presentation regarding the Corporation’s investment portfolio as well as our third quarter earnings press release which includes reconciliation of non- GAAP measures referred to on this webcast in the investor relations portion of our website as referenced in our press release this morning Ron.

Ronald Logue

Thank you Kelley Good morning everyone. We continue to navigate successfully through these slowly improving times seeking to build our base revenue represented by servicing fee and management fee revenue while at the same time focusing heavily on expense control.

The solid improvement in servicing and management fees being generated here is being somewhat obscured by the compressed spreads affecting both securities finance and net interest revenue and the volatility being experienced in trading services, all of which is being compared to the outsize results in 2008.

Now as I stressed last quarter what I'm looking for is sustainable progress over time. Growth in total revenue against continued expense control. Let's talk about revenue growth first.

As markets improve and as we add a new business our third quarter servicing and management revenue increased compared to the second quarter. In the third quarter we added $168 billion in assets to be serviced and we had $65 billion in net new assets at State Street Global Advisors particularly into passive and ETF strategies.

As the customers of hedge fund managers require an independent third party administrator we have seen solid growth in those assets. We added 29 customers year to date in that business, for which we will provide hedge fund servicing. This quarter as of September 30, 2009 our assets have grown 5% offering 263 billion as of June 30, 2009 to 276 billion.

In addition our private equity servicing business has added five new clients during the third quarter. And as of September 30, 2009, has $145 billion in assets under administration, up from $136 billion as of June 30th 2009.

Some of our investment servicing wins in the third quarter included building on an existing relationship. Calamos investments, appointed us to provide custody, fund administration and securities lending services to it’s several collective fund structures, including open and closed and mutual funds, double- end (inaudible) and private funds worth approximately $24 billion in assets.

Morgan Stanley Adviser Fund has appointed State Street to provide fund administration, including financial reporting and securities lending compliance for $36 billion held in its 89 mutual funds.

ING Bank of Canada recently chose State Street to provide custody and valuations for their corporate treasury assets of $6.9 billion Canadian as well as additional assets from ING Direct Asset Management.

Australian fund manager QIC, appointed us to provide a full range of investment services for their new Irish Domiciled Qualified Investment Fund. State Street will provide custody, fund administration and performance and analytic serviced for the fund.

State Street Global Advisors also added significant new clients during the quarter including Neuberger and Berman Group, which selected SSGA to provide taxable money market funds to Neuberger Berman fund share holders and clients.

AP Fonden- 1 Stockholm selected SSGA to manage $140 million in passive alternative investments. The London Borough of Harrow has named State Street Global Advisors to manage $163 million in UK passive equity mandate.

Also this quarter, we added five new customers in our securities finance business and the participation in the program has stabilized. Despite these positive wins, our revenue from our securities finance business declined from the second quarter primarily due to significant compression in spreads.

The level of revenue from trading services last year was primarily driven by significant volatility in the highly disrupted markets. Normalizing markets coupled with some seasonal slowness in the third quarter of this year negatively impacted trading revenue in the third quarter.

Net interest income increased 23% from the second quarter due primarily to discount accretion attributable to the consolidation of the conduits in the second quarter. Our net interest margin excluding discount accretion is lower but has stabilized helped by our reinvestment program which we began this quarter.

In early July, we began investing in highly rated securities mostly AAA rated agency mortgage backed securities and Ed will provide more detail shortly.

Spreads on fixed income securities have compressed significantly improving State Street's mark to market valuations in our investment portfolio. As liquidity return to the market, the unrealized losses are more than cut in half from the December level from $6.33 billion to $2.98 billion.

As we have consistently stated we believe the vast majority of our assets will mature at par. It has also become increasingly important to us as we operate in a lower growth environment to extend our core competency in expense control, which I think we’ve been demonstrating during this difficult period.

Again this quarter, we achieved positive operating leverage compared to last years third quarter. The investments we made during past high revenue growth periods are paying off in efficiencies without the sacrifice of quality. You will notice that other than the sequential quarter increase in salaries and benefits, due to accruing performance based incentive compensation beginning this quarter, compared to the second quarter, all other expense lines remain flat.

Growth in the second half of 2009, particularly in securities finance and trading revenue, does not appear to be quite as strong as we originally forecast on May 18, 2009 and confirmed on July 21. As a result, we are updating our outlook for operating revenue in 2009. We now expect our operating revenue to decline about 16% from the record level of 2008 and our operating earnings per share for the year to be between $4.13 and $4.17.

We expect operating return on equity to be within our long- term outlook of 14% to 17%. I also remind you that we are using approximately 475 million shares as the average shares available to support the calculation of fully diluted earnings per share on an annual basis compared to 416 million shares on average in 2008.

We are still working on our budget for 2010 and we will provide our outlook for 2010 at our meeting of investors and analysts next year. Now I will turn the call over to Ed.

Edward Resch

Thank you Ron. Good morning everybody. This morning I will review three areas. First the results of the third quarter, second the improvement in the unrealized losses as well as the overall performance of our investment portfolio and finally a review of our capital ratios and the execution of our tangible common equity improvement plan.

First the results of the third quarter. This morning all of my comments will be based on our operating basis results as defined in today's press release. Comparing the third quarter of 2009 with the second quarter, servicing fee revenue increased 5% and management fee revenue was up 13%, primarily due to market increases as well as new business wins. Both items were down compared to the third quarter of 2008 due primarily to market declines.

Clearly revenue from securities, finance and trading services was weaker when compared to either the very strong third quarter in 2008 or with the second quarter of 2009 while Foreign exchange revenue declined on both year- over- year in a sequential quarter basis, brokerage and other revenue which is reported as part of trading services was up 11% compared to the third quarter of 2008 due primarily to strength in electronic trading.

We had $396 billion of securities on loan on average in the third quarter of 2009 compared with $617 billion in the third quarter of 2008 and down from $418 billion on average for the second quarter of this year.

With spreads continuing to contract and assuming flat volume we expect securities finance revenue in the fourth quarter to continue to trend down from this year's third quarter.

Average lendable assets for the third quarter of 2009 were about $2.1 trillion, up 12% from $1.9 trillion in the second quarter of 2009, but down about 23% from $2.7 trillion in the third quarter of 2008, in line with market declines as measured by S&P 500 or the MSCI EFA.

The duration of the securities finance book is approximately 29 days. Compared to the third quarter of 2008, processing and other fee revenue declined 29% due primarily to the effect of the consolidation of the conduits onto the balance sheet.

Net interest revenue on a fully taxable equivalent basis increased about 18% from the third quarter of 2008 due primarily to the impact of the discount accretion.

Net interest driven on a fully taxable equivalent basis was up 23% from the second quarter of 2009 also due to the impact of discount accretion. Net interest revenue excluding discount accretion would have declined due to narrower spreads both in the investment portfolio and on customer deposits.

Net interest margin of 247 basis points, was up 54 basis point from the second quarter of 2009 on a fully taxable equivalent basis. Excluding discount accretion, the net interest margin would have been 156 basis points which, based on our fourth quarter expectation brings us to the lower end of our prior outlook for the average net interest margin of 170 to 180 basis points for the year.

We recorded $42 million of net securities gains and other than temporary impairment adjustments, about $141 million in gains and about $99 million in OTTI. The OTTI was primarily due to increases in expected future credit losses in US non- agency mortgage backed securities.

Regarding operating basis expenses; third quarter expenses declined 13% compared to the third quarter of 2008 and increased 9% from the second quarter of 2009. As you may recall we eliminated performance based incentive compensation in the first half of 2009 to support our tangible common equity improvement plan.

Note that compared to the second quarter of 2009 salaries and benefits expenses increased 18% primarily due to the $100 million accrual of performance based incentive compensation. However all other expenses line analysis remained essentially flat.

Salaries and benefits declined 20% in the third quarter of 2008 due primarily to the effect of our reduction in force, which was substantially completed in the first quarter of 2009 as well as a lower level of incentive compensation

Other expenses declined in third quarter of 2009, down about 8% from the third quarter of last year and were flat compared with the second quarter of 2009.

We will continue to be vigilant in managing our expenses. I indicated last quarter that we expect other expense on an annual basis to be down about 15% from last year. However given the slow and fragile economic recovery and a revised revenue outlook for 2009, we continue to remain discipline regarding any discretionary items and now expect other expenses to be down closer to 25 to 30% compared to other expenses in 2008.

Now let me turn to the investment portfolio. The average size of the investment portfolio in the third quarter has increased about $13 billion since the third quarter of 2008 excluding about $4.5 billion in assets held on deposit as of September 30th 2008 as a result of State Street's role as a intermediary in the Federal Reserve Bank's asset backed commercial paper money market liquidity facility, the AMLF.

This increase is due primarily to the consolidations of conduit assets as well as the execution of the investment strategy we announced last quarter offset partially by maturities and sales from the investment portfolio.

During the third quarter we invested about $14 billion in highly rated securities at an average price of 101.5 and an average yield of about 3.33% and a duration of about 2.25 years.

This $14 billion are primarily comprised of $11 billion in agency mortgage backed securities, the vast majority of which are rated AAA and $2.4 billion in asset- backed securities, the vast majority of which are also rated AAA.

The aggregate unrealized after tax losses in our available for sale and held- to- maturity portfolios were $2.98 billion, an improvement of about $1.77 billion from June 30th 2009 and up $3.34 billion or 53% from December 31, 2008. In our investment portfolio slide presentation we have updated the data through quarter end for you to review. As of September 30, 2009, our portfolio was 80.4% rated AAA or AA compared with 79.6% as of June 30, 2009.

Our aggregate credit distribution as of September 30, 2009 remains relatively unchanged from June 30, 2009 despite about $8.2 billion in downgrades. The primary reasons for this are our new purchases, which are primarily AAA rated and our conservative reporting of downgrades.

We report our credit distribution based on the lower of Moody’s or SNP. However we report all downgrades to you from either agency each quarter, even if security was previously downgraded by another agency. Approximately $3 billion of the $8 billion was previously reported as downgraded. Thus the new downgrades for the third quarter total about $5 billion.

There was also a positive impact on credit distribution due to our new purchases, which are primarily AAA- rated and due to the prepayment of securities rated below AAA. Most of these downgrades occurred in non- agency mortgages and most of these downgrades were due to rising foreclosures due to higher unemployment rates and the end of the moratorium on foreclosures at many banks.

However, we are seeing positive signs of stabilization in the U.S residential market from the Case Schiller index as well as the index of leading economic indicators. The former conduit assets now consolidated into the investment portfolio continue to improve in price during the quarter as general capital market conditions improve. Despite this improvement, projected credit fundamentals for certain securities have deteriorated in our view.

Compared to our previous estimate of $600 million, we now expect about $850 million or about 14% of the $6.1 billion pre tax charge we took in the second quarter upon consolidation of the conduits to not accrete back into net interest revenue over the remaining lives of the conduits assets.

The amount accreted back into net interest revenue in the third quarter was $279 million making a total of $391 million through September 30th 2009. We now expect about $600 million of discount accretion in 2009 up from our earlier estimate primarily due to faster pre payments on certain securities.

We still expect about $900 million to accrete back into net interest revenue in 2010, but we are adjusting our outlook for discount accretion in 2011 to about $700 million or $100 million lower than what we estimated at the time of consolidation of the conduits.

We continue to expect about 2/3rd of the total discount accretion to occur in the first five years after consolidation. As you are undoubtedly aware a great many assumptions going to such a calculation, including pre- payments speeds and credit assumptions across various asset classes.

Let me make a few brief remarks on our outlook for net interest margin for 2009. First of all 2008 was as you know was an anomalous year with unusually strong growth of net interest revenue and atypical net interest margin expansion. Our assumptions for net interest margin for the rest of 2009 are that we continue to execute on our second half investment plan.

We reinvest fourth quarter maturing assets of approximately $3 billion in highly rated agency mortgage backed securities and AAA rated asset- backed securities. We intend to maintain the duration of the investment portfolio and GAAP on our balance sheet approximately in line with where it is as of September 30th 2009.

At that time the duration stood at 1.07 years and the GAAP on the balance sheet was 0.15 years. We expect interest earnings assets to decrease between 3% and 4% during the fourth quarter of 2009 and this decline is dependent on the continued gradual improvement in the capital markets and our view as to the prudence of carrying lower levels of excess liquidity. We continue to expect the net interest margin to be between 210 and 220 basis points including discount accretion, on average for the year, excluding the impact of the AMLF in th4 first quarter of this year.

From a rate stand point we expect the Bank of England to remain at 50 basis points for the rest of the year, the ECB to remain at 100 basis points for the rest of the year and the Fed to keep over night Fed funds at about 25 basis points.

Lastly, I’ll briefly update our capital ratios and the progress against our TCE improvement plan.

In the third quarter our capital ratios continued to improve such that, as of September 30th 2009, compared to June 30th 2009, our tier one leverage ratio stood at 8.16%, up from 7.26%. Out tier one capital ratio stood at 15.55%, up from 14.53% and our tier one common ratio stood at 13.58%, up from 12.57%.

In the third quarter we improved our TCE ratio from 4.96% at June 30th 2009 to 5.73% at September 30th 2009, ahead of our original target of 4.29% when we introduced the plan in February. The majority of this improvement came from price improvement in the investment portfolio and organic capital generation offset partially by a larger balance sheet.

At the end of the year we are targeting our TCE ratio to be about 6.24 % with the effects of the fixed income markets on our investment portfolio and our actual financial results being the primary factors that could influence this result.

The details behind this target, displayed on a quarterly basis are listed on slide 15 of the slides detailing the investment portfolio which you can find on our website.

In summary, for the fourth quarter, we expect servicing and management fees will continue to modestly improve from third quarter levels, assuming equity and fixed income markets continue to be stable. That participation of our securities finance program will continue to firm but the reduce spreads will continue to restrain Securities finance revenue.

We expect net interest margin to be near the lower end of the 170 to 180 basis point range in 2009 excluding discount accretion and including discount accretion we expect net interest margin to be near the higher end of the 210 to 220 basis point range.

We expect to continue to maintain good expense control remaining committed to achieving positive operating leverage on annual basis and lastly we will continue to be cautious and grow our capital.

Now I will turn the call back to Ron.

Ronald Louge

So, while markets are beginning to normalize we are still seeing pockets of uncertainty especially in a consumer segment in which improvement is dependant on lower unemployment rates and as a result we are going to continue to be cautious.

On the plus side our pipeline continues to be strong although decision making continues to be slow as our customers are distracted by the many challenges of the unprecedented economic climate.

The sequential quarterly increases we have achieved in servicing the management fees in 2009 are building some momentum but the deep decline in spreads in the securities lending business are restraining growth.

The actions we took earlier this year resulted in our strong capital position and the momentum in our core business plus expense control; continue to position us well for a recovery.

Now Ed and I are happy to take your questions.

Question – and - Answer Session

Operator

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

Glenn Schorr - UBS

So we had some acceleration of some of the accretion this quarter on as you mentioned some of the prepayments picking up. So 2009 accelerates, 2010 stays the same, but 2011 moves forward. How come that’s not shared across the years? I don’t know if I am harping on something irrelevant, but it just seems weird to me that 2010 would stay the same, that some of that wouldn’t be pulled forward.

Edward Resch

Glen, it depends on our security specific analysis and we go through that for the quarterly determination, it really depends on what we see, security by security for those securities that we are targeting for future discount accretion. So, it's not a linear type of thing at all.

Glenn Schorr - UBS

Okay. I don’t know if I missed this in the prepared remarks, but what drove the processing fees jump up, I guess it's 45 from 17 last quarter?

Edward Resch

Nothing in particular. Just a combination of a lot of relatively immaterial items that resulted in the $28 million sequential quarter gain. So there is nothing specific to point to there.

Glenn Schorr – UBS

Okay. We’re starting to see a bunch of consolidation in asset management land, you have Ameriprise Columbia, yesterday you had Morgan Stanley Invesco. Just thoughts on some of the recent transactions on how you are impacted specifically and then just maybe just the more general view on consolidation asset management, how you are impacted?

Ronald Logue

I think we are continue to see more of that if past performance or any indication of future success there I think it will be positive for us and I can cite a number of cases the most recent one last I think last quarter we talked about when Wells and Wachovia merged we were doing the majority of the work for Wachovia, had done actually nothing for Wells Fargo and then won that significant piece of business. I forgot what the assets were I think there were about $230 billion. So we were major beneficiary there.

So we had two other situations. We got Columbia for whom we do most of the work purchased by Ameriprise for whom we do nothing and we have (inaudible) for whom we do everything, which is the deal that was announced I guess late last night, and Invesco in that situation we do a lot for Invesco as well.

So my sense is that we will be a beneficiary of that kind of consolidation going forward and that trend has been a long time trend actually going back five, ten years. We have seen that in many cases and usually we're on one side or the other lately we haven't been on the buying side, but because we have been doing so much for the seller it just an easier thing for the buyer to do and so we have been the beneficiary. I expect that will continue.

Glenn Schorr – UBS

The last one is just a theoretical question back on the securities portfolio. On the reinvest side, and my thoughts have changed over time as per the cycles we've just looked through. I get that you are buying high quality and reasonable duration MBS and ABS. But I guess the question I have is why, after everything we have lived through, I know capital ratios are much better, how come, go down that path? In other words they could wind up, they might say (inaudible) but they might rise a lot. Why take on the duration risk even if you feel good about the credit risk on the reinvest? Why not stay close to home and just deal with a little bit lower earnings in the near term but have a squeaky- clean securities portfolio?

Edward Resch

We’re trying to strike the right balance there Glen, to the question you’re asking and we’re not going down the path that you alluded to in your question about some of the other asset classes that blew out from a spread perspective. It’s a question of whether or not we want to really stay on the sidelines and give up the current earnings as well as positioning the portfolio for the future and we have made the decision and we think the risk award there makes sense. Recognizing that the rates are probably not going to go down. They are going to go up. But investing the 14 billion in the asset classes that we did, we think, makes sense for both the short term and the longer term.

Operator

Your next question comes from Howard Chen - Credit Suisse.

Howard Chen - Credit Suisse

I think you previously noted that pre- payment speech relating to the Condo would be in 8% to 12 % range, I was curious what that was during the quarter and generally where those are trending right now?

Edward Resch

No it’s slightly higher and trending towards slightly higher but not materially so.

Howard Chen - Credit Suisse

In the past you've given some helpful detail on lending spreads, Ron you made the comment in the prepared remarks we saw compression in the spreads there so just hoping for, a bit more detail.

Ronald Logue

In terms of Q3 versus Q2, if we can use that, the volume is down a bit from 417 last quarter to 395 this quarter, so that’s down about 5%, the spread went down from 88 basis points to about 50 basis point and virtually all of the revenue variants is due to the change in spread, I mean just a small percentage due to the 5% decline in the volume.

Howard Chen - Credit Suisse

Okay, and then I know part of this is a bit of a catch up with the return of the incentive compensation but if I look at some of this quarters fee revenue trends in particular, foreign exchange, we just touched in sec lending, some of the servicing fees. They look a bit lower when you are catching up with some of the incentive compensation.

So, I'm just curious, as we go forward how do we think about the pacing of the core revenues with incentive compensation accruals?

Ronald Logue

I think that in a more normalized environment Howard, I think that the way to look at the pacing of revenues against incentive compensation is based on where we’ve been historically which is approximately in the 40% of revenue range and that’s kind of long- term measure. It could be 38%, it could be 41% but in the range of 40% of revenues is probably the best way to think about incentive comp over a more normal time frame.

Howard Chen - Credit Suisse

And then my final on Ed, could you just touch on the current position of your balance sheet and sensitivity higher rates, I know, typically your balance sheets are normally viability sensitive, but my case, my sense is that’s not the case now, so, what's the composition again and what are the thresholds between, it could be in like a little asset- sensitive to becoming normally liability- sensitive? Thanks.

Edward Resch

Yes, I mean we are pretty flat. The duration gap is the smallest, it's I think been in a long time certainly in recent memory at about one to five years. So, we are pretty flat, we are comfortable with that, we think that given the investment objectives that we have, as I said, we will continue to be around that coming into year end, both from a GAAP stand point end, from the duration of the portfolio. But you are right, in a more normal, interest rate environment we would normally be in a liability- sensitive position and we would expect that to be the case over time, once things get back to normal.

Howard Chen - Credit Suisse

Okay, and just a clarification, I guess what's normal from an interest rate perspective in your mind?

Edward Resch

Hard to say, I mean we are - I think everybody agrees that where we are right now is not normal, but I don’t know, what's a normal Fed funds rate? 3%, 4% and it's hard to say, but clearly it's not 25- basis points.

Operator

Your next question comes from Mike Mayo - CLSA.

Michael Mayo - CLSA

Just to replay your guidance to the fourth quarter, is why is it with a $1.00 to $1.4, is that correct?

Edward Resch

Yes, that’s what it would work out to, yes.

Michael Mayo - CLSA

Okay and FX was down, and you guys buy a lot and it was not the banking your work is there anything going on there?

Edward Resch

No not that I can tell.

Michael Mayo - CLSA

As far as an outlook for that do you expect to stay down here?

Edward Resch

I think that I think we'll see the same level. Yeah I don't think we're go see necessarily a big jump there.

Michael Mayo - CLSA

And just be clear you're guiding lower for the fourth quarter or I guess you are guiding down to consensus. Is that solely due to less than expected security funding and a lower quarter margin or there is anything else going on?

Edward Resch

No it's mostly due to securities lending and foreign exchange.

Michael Mayo - CLSA

Okay, and your asset under custody were up 9%, your custody fees were up 5% so why, are you cutting margin or what's going on there?

Edward Resch

No, I think we talked about this in the past it's just the function of as you starting to add the asset and as the revenue starts coming in, nothing unusual there at all.

Michael Mayo - CLSA

So why wouldn't you expect an acceleration of those fees then?

Edward Resch

Well you may overtime as the assets begin to come on you start seeing that there has been a delay there, but there is nothing there is nothing unusual there at all.

Michael Mayo - CLSA

And you mentioned several new wins would that all be reflected? I guess it wouldn't be reflected yet. But your wins and I have asked this before, how much of new custody assets to the wins provide say a percentage of your existing asset under custody at ballpark even?

Edward Resch

That's the tough one you know small.

Kelly McDonald

I'll get back to with that Mike.

Operator

Your next question comes from Betsy Graseck - Morgan Stanley.

Betsy Graseck - Morgan Stanley

One cleanup question, you indicated 600 million fiscal year for the accretion, for the accredible yield and you had 279 this quarter. So I know that implies 321 but I can’t recall how much Q2 was.

Edward Resch

Q2 was 112 million. So we have reported about close to 400 million through the end of September Betsy.

Betsy Graseck - Morgan Stanley

So little over 200 for 4Q. And looking at your capital ratios with the TCE ratio expected to get to 6.25% and your target really is 5%, how do you think about capital management over the course of the next year and what are the trigger points for either a dividend increase or a buy back on the stock?

Ronald Logue

I think one of the big trigger points is going to be what the new Fed regulations for capital ratios are going to be. I think we have to take a look at that first and then make some decisions based on what’s there. But I think that probably will be the first trigger point right there, looking at what the capital ratios are and then making some determination in terms of dividend and then looking at what kind of opportunities, if there are any out there in the market place to take advantage of. So it will be some what situational but I think the first big trigger point is going to be what the regulators come out with in terms of new capital ratios.

Betsy Graseck - Morgan Stanley

I would think you are fairly close to the regulators. So do you have a sense as to where that dialogue is going at this stage?

Ronald Logue

No, actually we don’t know. But I’m assuming this is going to happen sometime soon.

Betsy Graseck - Morgan Stanley

Right. I think the G20 was looking for by the end of the year.

Ronald Logue

I would think so. Yes.

Betsy Graseck - Morgan Stanley

Once you feel like you have sufficient capital, how are you thinking about the dividend policy just generally?

Ronald Logue

All things being equal, obviously we want to get back to the point where we are paying a dividend similar to what we were paying in the past but I think we just need to see what the landscapes is going to look like. But generally speaking we'd want to get back to paying a dividend similar what we’ve done in the past.

Betsy Graseck - Morgan Stanley

Which was roughly 20, 25% range, is that fair?

Ronald Logue

Yes.

Operator

Next question comes from Marty Mosby - FTN Equity Capital.

Marty Mosby - FTN Equity Capital

I had a question concerning the net interest income. We are looking at the kind of the accretion that we are getting all for the investments that we put on board which is a positive. On the flip side we are getting this, now kind of negative in a sense of we are in the lower end. So we are one side on the upper end of the range and another in the lower.

So we kind of think about, how those two things would net out and where we are versus your long- term projections of where you think the margin would end up?

Edward Resch

The reason for one being on the lower end and one being on the upper end is the swing factor of discount accretion. If you exclude discount accretion from the calculation given the rate environment and given our conservative reinvestments, we are saying that we think we'll be closer to 170 basis points for the margin.

If you include discount accretion which is performing higher than what we expected when we consolidated the conduit, that’s the reason for the other range being at the upper end 220 basis point being the upper end.

Marty Mosby - FTN Equity Capital

All I was trying to get at is, if you kind of take the accretion and say well, really that’s not going to be there permanently. On the flip side, the negative that we are getting from the interest rate environment, also is it going to be there permanently.

So somewhere between 170 and 220, they kind of maybe normalize out on the next couple of years, because, we have enough of the accretion to keep us through as we wait for hedge rates to go up. Once hedge rates go up, then we get that benefit and that will help all sets on the loss of accretion in the out years.

Edward Resch

Exactly right.

Marty Mosby - FTN Equity Capital

I am just thinking of those two things as, you wouldn’t go in and just pull out that 50- basis points and say, that’s really an abnormal number. That really is a benefit that we are getting today that’s helping us offset and really just kind of accelerate our return to what would be a more normal long- term net interest margin once interest rates do go up.

Edward Resch

That's correct.

Operator

You next question comes from Gerard Cassidy - RBC.

Gerard Cassidy - RBC

The question I had, you mentioned the adjusted outlook for the full year of 2009 regarding revenue, the decline in revenue year- over- year from ’08 and then your expectations on operating EPS numbers. Can you give us some thoughts on what you are looking at for 2010?

Ronald Logue

I really can't. I think it's too early for that right now Gerard. Obviously we are working through that now, we will talk about that, early in the year as we normally do, but it's really too premature to get a sense of that right now.

Gerard Cassidy - RBC

Okay, and then the second question was in the securities lending business, you indicated in the past that as a result of the disruption in the marketplace, some of your customers have pulled out of that business and you have been slowly but surely getting them back. Can you give us an update on that business, how many customers that we are actively involved and securities lending have come back and what's the potential?

Ronald Logue

Yes, I think we said, we’ve got five more came back this time, but –.

Kelly McDonald

26 came back.

Ronald Logue

26 came back. Okay. What I would say is we’re probably even in terms of customers right now. We're down just a little bit, Ed would you agree with that.

Edward Resch

Yeah, close to even. (inaudible).

Ronald Logue

Maybe a little bit back..

Gerard Cassidy - RBC

Customers are back.

Operator

Your next question comes from Vivek Juneja - J.P Morgan.

Vivek Juneja - J.P Morgan.

Couple of questions Ronald. Firstly on the update for other expense, you talked about it going down 25% to 30% versus (inaudible) so obviously that's something that you've increased given that turning at a lower run rate. Any color onto the one the kinds of items and how should we think about what scenario or what drivers would cause that to go back up?

Ronald Logue

Let me start I think one of the things we tried to do over the years is to create as much variable expenses we can so to the extent that we can do things with contract is in terms of IT as an example or other type of professional services where we can decrease that rather quickly as suppose to adding staff. I think we have a done a good job in doing that so we had more freedom in our ability to do those kind of things. And I think we beginning to see that reflected in the other expenses. I don't know if you had…

Edward Resch

Yeah, that's the largest element, or the largest lever we have is professional services contractors to address certain short- term or very specific technical needs, but we have other areas of that line which are sales promotion and travel and entertainment and a whole series of miscellaneous items that we can clamp down on and frankly we have this year given what we have seen on the top line.

The opposite was true obviously as Ron alluded to in prior years where we had the ability to calibrate some of those expenses up and get ahead of some various IT projects and things like that by using contractors and various consultants.

Vivek Juneja - J.P Morgan.

Great. That’s helpful, so that as business comes back that’s what will drive expenses.

The discount accretion went up for the near term but you have reduced it for ‘011. As you think about that, how much would, because of your expectation for pre- payment speeds going up. How much would long term risk need to go back up for that to reverse back to where you were three months ago because long term rates move but not that much? So if they move back another 50 basis point or so, would that mean that you go back to where you were in terms of your discount accretion or can you talk on that?

Edward Resch

Our change in outlook for discount accretion Vivek, is more actually centered on out assessment of future credit expectations. It does not have much to do on a go- forward basis with the change in prepayment assumptions. We’re still thinking about the range of 8 to 12 on the CPR. So when we brought it down, it’s more a question of specific credit analysis on specific securities that caused us to change our view. That is the opposite of what we have seen so far this year where we have actually generated more discount accretion since the consolidation because of slightly higher prepayment speeds.

Operator

Your next question comes from Brian Bedell - ISI Group.

Brian Bedell - ISI Group

Did you say that you expect about 850 million of the 6.1 billion shortage to not accrete ultimately? Did I get that right?

Edward Resch

Yes

Brian Bedell - ISI Group

If the decline in the 800 million to 700 million of discount accretion in 2011, is that due more to your modeling, sort of higher default rates, or is it more due to the advancement of from the prepayments fees, the advancements that you are seeing in the currents periods here.

Edward Resch

It's the former. It's based on our change of view on certain securities from a credit perspective.

Brian Bedell - ISI Group

On the tax rate outlook, what's your outlook for the fourth quarter?

Edward Resch

We said that, we thought would be for the full year between 29 and 30% and I think that’s the number in the press release.

Brian Bedell - ISI Group

A little bit moreof the picture, first on the asset servicing side. Looks like you've won so far, just in keeping track of this, year- to- date about 620 billion of new business and coming into this year, I think you said you had 317 billion, sort of that was yet to be installed.

How much of you have installed in the third quarter and then what sort of you might be installing in the fourth quarter, just to get sort of the trajection of your new business into the revenue stream?

Ronald Logue

I can't give you an exact figure but I would say a good portion of what we talked about last time has or continues to be installed between now and near end and I would assume what we've announcing today will, some of it will being to be installed in the fourth quarter but normally it would flow over into the first and second quarter of next year.

Brian Bedell - ISI Group

So some of the wins that you had in the first half were still being installed in the third quarter?

Ronald Logue

Yes, because they are longer, Wells is a good example, that’s going to take some time, that’s a big chunk.

Brian Bedell - ISI Group

Has Wells been installed yet?

Ronald Logue

No that’s in process.

Brian Bedell - ISI Group

Okay, it's in the process, okay. So that’s not really in the revenue run rate at this stage.

Ronald Logue

No.

Brian Bedell - ISI Group

Okay. And then, just a couple of other ones, like brokerage fees, was that helped by more transits in management revenue this quarter?

Edward Resch

It was helped by the electronic trading platform, we have specifically the Currenex.

Brian Bedell - ISI Group

Currenex. Okay, so that was doing well. Okay. I guess because retail APEX trading is out right now. Then securities lending, spreads down to 50 bips, you expect further spread compression in the fourth quarter in that book?

Edward Resch

No, I think about the same, maybe a little.

Brian Bedell - ISI Group

About the same. Okay. And then just looking at I guess the longer- term, I know you are going to update your guidance with your February meeting. But should we still think of the company as a basic 10% to 15% EPS growth and that’s been you said a long- term target for a while. From the reduced guidance base that we have this year, if we go into 2010 and revenues are still sluggish from sort of a weak macro backdrop, do you have enough expense flexibility to at least have the 10% type of EPS near the bottom of your long- term range?

Edward Resch

First of all, we are not going to retreat from our long- term goals, those are going to continue to be our goals for us going forward. I can't tell you what's going to happen next year. Do we have some flexibility in the expense ID, I think we have some flexibility. But what I feel good about is that the basic core fundamental revenue streams that attract customers, service fee revenue, management fee revenue continues to grow sequentially quarter. And from that, as markets change, will come the other revenue from those new customers.

So what I am focusing on right now was those acquisitions of new customers and the fundamental core business represented by servicing fee revenue and management fee revenue, because history has shown that once you have that core revenue, the rest of that that, whatever you want to call it, market driven revenues, securities lending, foreign exchange, transition management, all that, follows pretty closely.

So what's happening right now is we are, I think successfully building that core revenue from which the additional revenues, including NII, which creates the basic inventory for NI comes along. So that what's been going on in 2009 which I think and will continue in 2010 and so I would hope as markets normalize you begin to see those other revenue streams growing on the backs of these new wins.

Brian Bedell - ISI Group

Right and you will be able to lag your deposit pricing I would assume, when the Fed raises rates or if there is a global coordination of

Ronald Logue

We have done that in the past lagging rights on the liability side yes.

Brian Bedell - ISI Group

Right. And then just lastly on the expenses, any major investment projects in the last year you did, you did some international stuff with Canary Wharf…

Ronald Logue

Yeah, we have got lot of that behind us, and one of the decisions we've made in the high revenue growth period is we made a lot of investment. The outsourcing business, the middle office outsourcing is a good example of what we have done, moving into Canary Wharf taking care of a new building in Ireland and a lot of that stuff passed us so I feel pretty good about that.

Brian Bedell - ISI Group

Right great thank you very much.

Operator

Your final question comes from John Stilmar - SunTrust

John Stilmar - SunTrust

Really quickly can you differentiate for me specifically going back to Sec lending, with the drop, it seems like most of it is basis point related and not necessarily absolute balance outstanding. Typically we see in the third quarter that there is some seasonal decline in demand for securities lending and we see that demand pick up in the fourth quarter.

But if we just look at the balances themselves they need not exhibit some of that traditional seasonal decline whereas it was more of a pricing decline. So can you help characterize my expectations for the fourth quarter vis- à- vis what is traditionally seasonal versus what the margin guidance or the margins you have set for this business which might me a bit more cyclical.

Edward Resch

No, the typical cycle has been high second quarter, lower quarter and about the same I’d say in the fourth quarter. So it maybe a little up- tick but traditionally what the cycle has been, I don’t anticipate anything different this year.

Ronald Logue

Our guidance for the remainder of the year assumes a flat level of securities on loan. We think that’s a prudent thing to do given what we’re seeing in the securities lending business right now.

John Stilmar - SunTrust

Can you talk about, just given the lower margins in securities lending and the fact that it’s an integrated product a lot of times with custodial and other types of services that you provide, especially as you are expanding into hedge funds, can you talk about the pricing of some of your custodial businesses and should we be expecting, back to Mike’s question earlier about the revenue in basis points for assets under custody, can you help me think about what the trajectory might be of that growing in the future to the extent that Sec lending is not as profitable maybe on a go- forward basis as we reset to new valuation paradigms?

Edward Resch

I think the first thing I have to do is repeat what we’ve said a number of times. And that is the discipline that we apply here in terms of not subsidizing the core businesses based on the anticipation of gaining either securities lending or foreign exchange or something that we've had a very strong discipline about. So that, if things like this happen the core revenue streams are not dramatically affected.

So we have been pretty good about that for years and continue to be and I think that will play well for us going forward.

Ronald Logue

Thank you, I don’t have any other closing remarks and we look forward to seeing you again some time soon. Thank you.

Operator

This concludes today’s State Street Corporation’s Third Quarter Call and Webcast.

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